Soaring US inflation pushed the EUR/USD pair to a fresh 17-month low as expectations of a Fed rate hike in October grew. However, as is often the case, the market initially overreacted before beginning to stabilize. Let’s take a closer look at the situation and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- US inflation accelerated to a five-month high.
- Expectations of an October rate hike surged before retreating sharply.
- Kevin Warsh may surprise the markets.
- Short positions can be opened on a pullback from 1.1280 or 1.1340.
Weekly Fundamental Forecast for Dollar
The Fed needs time to assess the situation, and the markets seem willing to give it that time. US inflation accelerated to 3.7%, while core inflation rose to 2.6%, driving the odds of an October federal funds rate hike as high as 50%. However, those odds soon plunged back to their initial level of 22%. The Fed could hold rates steady for now and, if inflation continues to accelerate, deliver a 50-basis-point hike in December. Against this backdrop, the EUR/USD has been on a roller-coaster ride.
US Inflation Change
Source: Wall Street Journal.
Core inflation has exceeded consensus forecasts for the second consecutive time. Consumer prices have climbed to a five-month high and remained above the Fed’s 2% target for 66 months. This is only the third time in the past century that inflation has stayed above the central bank’s target for more than five years! Of course, this is neither a disaster nor a repeat of the 1970s. Still, for a central bank firmly committed to bringing inflation back to 2%, it is hardly encouraging news.
In fact, I anticipated this kind of reaction from the EUR/USD and recommended buying on dips. After all, we cannot rule out a surprise from Kevin Warsh in Bangkok. Let’s not forget that Donald Trump appointed Warsh as Fed Chair and continues to defend him, even as the president remains eager to see interest rates fall.
Warsh’s primary task in the early stages of his tenure is to earn the FOMC’s trust. A series of hawkish signals, including remarks at Jackson Hole and the September Fed meeting, fueled expectations of monetary tightening and strengthened the US dollar. Yet in July, when the Fed Chair suggested that the Treasury market was already doing some of the central bank’s work, the greenback plunged. Could history repeat itself? With the primaries approaching, might Warsh have an opportunity to pull off another hat trick and bring the US dollar back down to earth?
Market Expectations for Fed Funds Rate
Source: Bloomberg.
Judging by the remarks of centrist FOMC members—including New York Fed President John Williams, Fed Vice Chair Philip Jefferson, and even Christopher Waller—Kevin Warsh appears to have earned their trust. Policymakers are increasingly signaling that a pause is in order. Meanwhile, with Treasury yields at levels last seen in 2002, Warsh can reiterate that the bond market is already doing part of the Fed’s job.
Can the US dollar recover from another dovish surprise? After Warsh’s July setback, the greenback had to wait until Jackson Hole for a potential catalyst. This time, the outlook appears considerably more favorable. France’s budget troubles and the inflationary pressures associated with artificial intelligence could eventually weigh on the EUR/USD. No matter what comes out of Bangkok, these underlying forces may ultimately prove more important.
Weekly Trading Plan for EUR/USD
Against this backdrop, short positions on the EUR/USD can be opened if the pair rallies and then pulls back from the 1.1280 or 1.1340 resistance levels, or if the euro fails to hold above 1.1210.
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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