The current inflation in the US is at the highest levels over the last 4 decades. The US dollar has been notably rising. The US Fed may increase the interest rate several times in the next 2 years. Together, these facts and prospects may intimidate traders who simply want to keep trading EUR/USD and other pairs with USD. This article aims at helping them develop a better understanding of the possible dynamics with USD.
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US Economic Outlook
Largely, domestic inflation in the US was driven by the vast increase in money supply over the last few years in the US. The increase in the prices of goods produced last year was one of the consequences. Particularly, food and global oil prices have risen across the globe and in the US.
The data from the United States Bureau of Statistics indicates that in April 2022, the month-on-month inflation increase was 0.3% against the previous month in the US. The year-on-year increase in April 2022 against the same month in 2021 was 8.3%. The latter is the highest figure in recent decades. That points to the accelerating inflationary dynamics in the US that have had a detrimental effect on the US economy.
The above may explain the US Fed’s tendency to tighten the monetary policy faster than previously planned. Rising wages and lower unemployment in the country are additional factors that may have possibly contributed to the Fed’s choice of this policy. Generally, the Fed is expected to keep raising its benchmark interest rate to reduce inflation.
The rate hikes will likely make the US dollar rise.
As a result, the world currencies will likely lose their relative value against USD.
Global Economic Outlook
The Conflict in Ukraine and the Global Economic Risks
In 2022, the US Fed Chair, Jerome Powell, noted that the Russia-Ukraine conflict may threaten global economic growth and bring additional inflationary risks. While leaders of other countries’ central banks supported that opinion, international sanctions against Moscow continued coming. Nevertheless, the Kremlin’s stance didn’t seem to be much affected.
Two years after the beginning of the pandemic in 2020, the coronavirus returned to the global agenda. China reported high infection rates and announced strict lockdowns in major cities. Europe lifted restrictions at the time when the virus hit the region with a new wave of infections. As a result, the number of cases soared again.
Together with the failing negotiations around the Ukraine conflict, the contradictory pandemic reports instilled anxiety in the global economic sentiment.
Impact on the EUR/USD
The European Central Bank (ECB) announced likely rate hikes. Normally, a sooner-than-planned interest rate increase would bring a positive vibe to traders and push the national currency up. That was not the case with the EUR. The sell-off of this currency indicated that investors were concerned about stagflation.
The prospects of high inflation and unemployment rates combined with slow economic growth, or stagflation, appeared as a serious economic risk to them.
EUR/USD has been plummeting since May 2021. The cautious market sentiment led to safe-haven flows to the US dollar which pressed EUR/USD downwards. EUR was further pressured by the economic threat that the Ukraine crisis may bring to the Eurozone.
Despite the fact that the ECB President, Christine Lagarde, commented that the Eurozone does not see any sign of stagflation. The currency pair remains in a downward trend.
From the technical analysis point of view, we see that there is a big deviation of EUR/USD from the 200-SMA. Consequently, we can expect corrections from EUR. The nearest resistance level is situated on 1.06420 (the local highest high from the 5th of May).
According to classical options analysis, PUT-options with a strike price of 1.07500 and an expiration date of two months have DELTA that equals 0.69. It means that the majority of traders believe that the price will stay below the level of 1.07500 during the following couple of months. According to the latest CFTC report the amount of long positions on EUR significantly increased.
EUR/USD will mostly still be driven by geopolitical factors.
The market perception regarding the development of the Russia – Ukraine conflict combined with the contrasting monetary policy of the Fed and the ECB will remain the central theme influencing EUR/USD.
Therefore, we suggest traders pay attention to these factors while making decisions on opening long or short positions. We don’t expect the energy prices to decrease if the conflict continues. Consequently, inflation will likely keep rising. Note that this is not consumer inflation, but the inflation that depends on the factors which are out of the US Fed’s or ECB’s control, at least for now. Moreover, the inflation situation will likely deteriorate because of the monetary easing line kept in the last two years. We believe that under such circumstances investors would rather prefer to buy US dollars than to keep euros.
According to some forecasts, we will see the parity in EUR/USD quite soon. It means that all upward corrections in the price movement of EUR/USD can be seen as a chance to increase long positions in USD. So, will the USD rise? We believe the probability of that is extremely high.Trade EUR/USD
Risk warning: The content of the article does not constitute investment advice and you are solely responsible for your trading activity and/or trading results.
Inflation is lost value in a currency due to an increase in the circulation of that type of currency that often leads to the decline of its purchasing power over time.
The Federal Reserve System, or FRS, is often called the Fed. It is the central bank of the United States and arguably the most powerful financial institution in the world.
Jerome H. Powell has been a member of the Board of Governors of the Federal Reserve System since May 25, 2012, appointed by President Barack Obama to fill an unexpired term.
Stagflation is a combination of high inflation and unemployment, and very slow or negative economic growth.
A put option, or “put”, is a contract giving the option buyer the right, but not the obligation, to sell, or sell short, a specified amount of an underlying security.
Strike price is a set price at which a derivative contract can be bought or sold when it is exercised.
Delta (Δ) is a risk metric that estimates the change in price of a derivative, such as an options contract, given a $1 change in its underlying security.
The Commodity Futures Trading Commission, or CFTC, is an independent federal agency that regulates the derivatives markets, including futures contracts, options, and swaps, in the United States.
Parity price describes a price level in two or more assets that represent equal or equivalent value.