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Markets are betting on interest rates. Which central bank will lower them faster and stronger, the Fed or the ECB? However, investors should rather focus on economic growth. Let us discuss the Forex outlook and make up a EURUSD trading plan.
A strong economy means a strong currency. Markets buy the news and sell the facts. These two principles of fundamental analysis work perfectly. The problem is that many economic indicators are lagging, so the movement of certain currency pairs in Forex can only be explained after the fact. The US economy was a pleasant surprise, while the European economy was teetering on the brink of recession. However, expectations for future GDP growth in the US and the euro area are different. The narrowing divergence in economic expansion rates encourages the euro bulls.
The World Bank reported that the global GDP in 2023 surpassed estimates of 2.1% and expanded by 2.6%. The main reason cited is stronger economic growth in the United States of 2.5%, which accelerated from 1.9% in 2022 and was more than double the forecast of 1.1%. It was the USA that drove the global economy last year, not China, whose gross domestic product of 5.2% was below the 5.6% expected by the World Bank.
BNP Paribas believes that the weakness of the euro-area economy will force the ECB to cut interest rates earlier than the Fed. Markets expect the first step from Christine Lagarde in April, but this could happen in March. The Federal Reserve is expected to ease monetary policy in May, and an earlier start in March has not been ruled out. At the same time, BNP Paribas predicts a rise in the euro-area economy and a slowdown in the US GDP in 2024. As a result, the divergence in economic growth will narrow, which will support the EURUSD.
Suppose the export-led euro-area economy was damaged more than the US one by supply chain disruptions due to the pandemic and the war in Ukraine, then the euro-area economic rise is natural. The supply shock is gradually easing, and supply chains have recovered to pre-COVID-19 levels. It is time for the euro bulls to go ahead.
At the same time, supply shocks become a thing of the past, and inflation returns to the targets of central banks. However, a stronger US economy increases the risk of a rebound in consumer prices, so markets are wary of the upcoming US inflation report for December. If actual data exceeds expectations, the Fed will have a strong case for keeping the federal funds rate at 5.5%. ING even believes that easing monetary policy requires a significant increase in unemployment and a drop in wage growth rates almost to zero.
So, the US economy is strong, but investors are betting it will slow down. The euro area, on the contrary, is weak but has room to grow. If the divergence in economic growth really narrows, EURUSD will rise to 1.12 in 2024, possibly to 1.15. However, in the near future, the key benchmark for the pair will be the US inflation report for December. I don’t recommend entering any trades yet.
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