As stock indices continue to rally, the derivatives market points to a high risk of a sell-off in the US dollar. The currency is sold on rumors of Jerome Powell’s possible dovish rhetoric. When is it time to buy on the facts? Let’s discuss this topic and make a trading plan for the EURUSD pair.
The article covers the following subjects:
Highlights and key points
- Market sentiment has shifted away from concerns about recession.
- Investors are anticipating a 25-basis-point reduction in the federal funds rate.
- Analysts speculate that Jerome Powell will adopt a dovish stance in his remarks.
- The inability of the EURUSD pair to maintain above 1.1065 is a negative sign.
Weekly US dollar fundamental forecast
The outlook for financial markets is positive, with a low probability of adverse changes in the short term. US stock indices have continued to demonstrate growth, mirroring the resilience observed in November. For investors, the outlook suddenly became clear: the likelihood of a recession is minimal, and the Fed is expected to cut the federal funds rate by 25 bp in September. Given the relatively modest start to monetary expansion, the greenback is likely to face greater pressure than it would have done had there been a 50 bp cut. Some may view this as an indication of an imminent downturn. If there is no such occurrence, why would one sell the EURUSD pair?
In the view of San Francisco Fed President Mary Daly, it is now time for a monetary policy adjustment. However, the Fed should adopt a gradual approach. Her colleague from the Federal Reserve Bank of Minneapolis, Neel Kashkari, concurs with her assessment. A measured approach is the optimal solution when the precise target is unclear. If the state of the labor market were to continue to deteriorate significantly, the central bank should have taken more prompt action. For now, there is no reason to cut rates by half a point at once.
Investors are expecting roughly the same rhetoric from Jerome Powell in Jackson Hole and are actively hedging the risks of a further fall in the USD index. Premiums on put options are higher than on call options, which translates into lower reversal risks and fuels the EURUSD rally.
USDX performance and risk reversals
Source: Bloomberg.
In a recent survey of 101 Bloomberg experts, 55 respondents indicated that they anticipate the Fed will reduce the federal funds rate by 25 bp at each of the remaining FOMC meetings in 2024, specifically in September, November, and December. A total of 34 respondents expected two acts of monetary expansion, while one respondent favored one act, and 11 respondents favored four or more acts. The derivatives market is characterized by more aggressive pricing. The company anticipates a 100-basis-point decline in borrowing costs this year. This would only be a realistic possibility should the US economy experience a notable decline. Thus far, there is no evidence to suggest that this is a likely outcome.
For instance, the majority of experts surveyed by Reuters have revised their forecast for US GDP growth in 2024 upwards. The current figure stands at 2.5%, which is significantly higher than the Fed’s expected 1.8%.
Consequently, the Fed will likely commence the cycle of monetary policy easing in September. Furthermore, the structure of inflation demonstrates that the components that the central bank is able to control are currently growing. This is, first of all, about prices for services.
US inflation change
Source: Bloomberg.
Weekly EURUSD trading plan
The ongoing rally of US stock indices on expectations of signals from Jerome Powell in Jackson Hole about the imminent start of monetary expansion provides an opportunity to buy the EURUSD pair on rumors and hold long trades formed at 1.1015 open. Nevertheless, the speech by the Fed chief may prompt a sell-off based on the facts. Therefore, it would be prudent to identify potential pivot points. There is a risk that the pair’s failure to maintain above 1.1065 could result in a significant sell-off.
Price chart of EURUSD in real time mode
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