Battle for Stability: USD Struggles to Maintain Position in Latest Forecast

By Gustavo Nils Dec20,2023

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USD Tries to Defend Itself. Forecast as of 20.12.2023

The Federal Reserve did not resist the will of the financial markets, but they wanted more. Expecting six monetary expansions in 2024 seems excessive, but the outcome will depend on the data. Let’s discuss this topic and make up a trading plan for EURUSD.

Greed rules the market. As a result, the S&P 500 is about to update its all-time high, the Nasdaq 100 has already reached a new maximum, and the Dow Jones has updated its high for five days in a row. The main victim is the US dollar, which is losing ground against major world currencies, with the exception of the yen, which was disappointed by the decision of the Bank of Japan.

Over the past year and a half, the Fed has persistently fought the markets, rejecting their ideas of ending the cycle of monetary restriction and a dovish reversal. However, in December the US regulator stopped doing this. The reason is data. Inflation has been close to target in five of the last six months. Disinflation is developing faster than the central bank expected. According to Jerome Powell, the Fed believed that the last stage of the fight against high prices was the most difficult, but so far this is not the case.

The market usually exaggerates everything. Once investors thought the monetary tightening cycle was over, they began betting that borrowing costs would fall. When the FOMC predicted three acts of monetary expansion, markets wanted six. The same goes for inflation. Investors are confident that it will fall to 2% almost in the first quarter of 2024.

Thus, only data can resolve differences between the Fed and investors. If lowering prices from 3% to 2% actually proves more difficult than lowering prices from 9% to 3%, the Fed funds rate may not even fall to 4.75%. Not to mention 4%, as derivatives predict. This will strengthen the US dollar. However, for now the EURUSD bears have gone into deep defense. This is facilitated not only by the rally in US stock indices, but also by comments from ECB officials.

The head of the Bank of France, Francois Villeroy de Galhau, insists on keeping the deposit rate unchanged for a long time. After all, if it is reduced prematurely, inflation risks returning to the eurozone. His Lithuanian counterpart Gediminas Simkus noted that markets were overly optimistic about the prospects for easing monetary policy. The head of the Bank of Croatia, Boris Vujcic, believes that the only thing that would justify market rates is a sharp slowdown in inflation. The ECB would be surprised by this.

Inflation will not decrease that quickly, so it is too early to discount the US dollar. However, market greed could push EURUSD above 1.1. The strategy of selling the pair on growth towards the upper limit of the range of 1.08-1.1 is still working out. It is possible to add up to short trades at 1.094 and 1.091. However, a breakout above 1.1 will change the situation.

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