Markets are once again playing a familiar game with the Fed. News of a truce revived expectations of rate cuts. In reality, the central bank is likely to stay on hold. The US dollar may take advantage of this misjudgment. Let’s discuss this topic and make a trading plan for EUR/USD.
The article covers the following subjects:
Major Takeaways
- The EUR/USD rally appears excessive.
- The Fed is unlikely to cut rates.
- The euro risks losing momentum as the TACO effect fades.
- As long as EUR/USD remains above 1.164, long positions prevail.
Weekly Fundamental Forecast for Dollar
Markets, like life itself, are shaped by mistakes. Donald Trump is mistaken in claiming a total US victory, as Iran continues to control the Strait of Hormuz. Investors previously overestimated central banks’ willingness to tighten monetary policy amid the Middle East crisis. Now they have moved too quickly to price in a federal funds rate cut. This drove EUR/USD sharply higher, but reality soon set in.
In fact, the only reason the Fed might return to monetary easing would be a prolonged Middle East conflict, which would trigger a US recession due to an oil shock. Even if peace follows the two-week ceasefire and negotiations, Brent is unlikely to fall significantly. This implies rising inflation risks, reinforcing the Fed’s incentive to keep rates unchanged. Markets are misjudging the situation, and this is one of the US dollar’s hidden advantages.
Market Expectations for Fed Rate Changes
Source: Wall Street Journal.
Another factor is the shift from TACO to FOMO. Since early April, EUR/USD bulls had been waiting for their moment. They were counting on negotiations and betting on a TACO scenario. This strategy has driven 9 out of the 10 largest gains in the S&P 500 since the Republican took office. Holding equities only during such periods, driven by FOMO, would have yielded 52%, compared to 12% under a buy-and-hold strategy.
The problem is that the TACO-driven impulse fades quickly. The two-day surge in EUR/USD following news of a US–Iran truce is a clear example. The gap between the sides remains wide. Donald Trump calls the outcome a total victory, even though Iran retains about half of its military capabilities and continues to control the Strait of Hormuz. During the ceasefire, around 10 tankers were allowed to pass while transit fees continued to be charged. It appears that the US president is counting on a share of these revenues. Whether he will get it remains uncertain.
More importantly for the market, oil was sold off too quickly, found support, and is likely to remain at elevated levels for some time. In this scenario, consumer prices in the US will accelerate, with core inflation following. This will force the Fed to keep the federal funds rate at current elevated levels. Markets are misjudging the situation, and combined with fading upward momentum in the euro as the TACO effect plays out, this increases the risk of consolidation in EUR/USD.
Weekly Trading Plan for EUR/USD
This is hardly the best time to take aggressive positions. Cautious buying while EUR/USD remains above 1.164, with a shift to selling if the pair falls below this level, appears to be the most reasonable approach. In any case, it is important to stay level-headed while awaiting updates on US–Iran negotiations.
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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