The services PMI report revealed the first signs of stagflation in the US economy. This puts the Fed in a very difficult position. Other central banks are no better off. Let’s discuss this topic and make a trading plan for EUR/USD.
The article covers the following subjects:
Major Takeaways
- The US ultimatum deadline to Iran is approaching.
- Stagflation is emerging in the US economy.
- The Fed is in a better position than its peers.
- A breakout below 1.152 and 1.149 is a signal to sell EUR/USD.
Weekly Fundamental Forecast for Dollar
The winner takes it all. Donald Trump believes that the US should collect fees for tanker transit through the Strait of Hormuz, as the US sees itself as the winner of the conflict. However, Iran currently controls transit through the strait, allowing selected countries, including Iraq, to pass in exchange for payment. Tehran rejected mediators’ proposal for a 45-day ceasefire, which pushed EUR/USD lower after a modest rebound.
Time is running out. Donald Trump’s ultimatum expires on Tuesday, although there is hope it will be extended once again. Strikes on Iran’s energy infrastructure would push oil and gas prices even higher and fuel inflation in the US. This would contradict the White House’s campaign promises and increase the risk of Republican losses in the midterm elections.
Indeed, the first signs of stagflation are already emerging. The services PMI price index surged in March at the fastest pace in 14 years, while labor market conditions have deteriorated. This led to a slowdown in business activity, a leading economic indicator.
Dynamics of Prices and Employment in the US Services Sector
Source: Bloomberg.
Stagflation is an extremely uncomfortable scenario for the Fed. High inflation typically calls for rate hikes, while a potential recession requires rate cuts. The central bank is caught between conflicting pressures, and the futures market expects it to keep borrowing costs unchanged. The chances of monetary easing are fading rapidly, which supports the US dollar.
Fed’s Rate Change Probability
Source: Bloomberg.
The dominance of the greenback on Forex may seem surprising, as derivatives markets expect much more aggressive moves from European central banks. According to their forecasts, the ECB deposit rate could rise by 75 basis points, while the Bank of England’s repo rate may increase by 50 basis points. Before the Middle East conflict, markets expected no changes from Frankfurt and even anticipated two rounds of monetary easing from London.
However, fighting oil-driven inflation with tighter monetary policy looks like a mistake. Central banks can effectively combat excessive demand, as seen after the pandemic. The current oil market crisis is driven by supply shortages. Raising rates in such conditions would be another blow to their own economies.
The Fed’s more cautious stance appears far more rational, and the US economy is more resilient to the energy crisis. Combined with rising demand for safe-haven assets amid potential geopolitical escalation, this supports continued demand for the US dollar.
Weekly Trading Plan for EUR/USD
A pullback in EUR/USD toward 1.157 has created an opportunity for short positions. The pair’s failure to hold above 1.152 and 1.149 will allow traders to build up shorts.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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