12.10.202217:03 Forex Analysis & Reviews: The dollar plays long

The turmoil in the British debt market, which affects both the pound and other European currencies, is no match for the Fed's monetary policy. The latter, according to US Treasury Secretary Janet Yellen, determines the fate of the US dollar, a much more significant currency for Forex than sterling. And yet the fires in the financial markets are so interesting, they attract attention.

The resuscitation of British QE for £65 billion until October 14, Andrew Bailey's reminder that pension funds have only three days left to resolve issues related to the sale of bonds, and, finally, rumors that the Bank of England is still prolonging the program shook EURUSD out of the way to the side. In fact, the ECB has very similar problems, but not with pension funds, but with the fragmentation of the eurozone debt market. The European Central Bank may also be forced to combine the incongruous. Tighten monetary policy and loosen it at the same time. And this circumstance does not add whists to either the pound or the euro.

Fears that Christine Lagarde and her colleagues might take a step back after two steps forward are not the main reason for the EURUSD downward trend. It all depends on the Fed. How long is it going to raise rates to bring high inflation to its knees? At first glance, the answer is obvious—up to 4.6%. This is the median estimate that appears in the latest FOMC forecasts. Alas, but this level in fact may not be enough.

The acceleration in consumer prices is based on the high rate of wage growth. According to Nordea estimates, the Fed needs to slow down the latter indicator from 5% to 3.5% in order to return inflation to the 2% target.

Dynamics of inflation and average salary in the USA

This will only happen if the unemployment rate rises from the current 3.5% to 4.5%, which will take a long time from 10 million new vacancies. For such a decrease in the indicator, employment must rise to 50,000–75,000 per month and be kept at this level for a long time. So far, this looks very problematic. Unless the US plunges into a deep recession, which the White House says is unlikely.

I do not rule out that the federal funds rate will eventually exceed 5% in this cycle. That is, current market expectations are underestimated, and their growth is a reason to buy the US dollar. I will also assume that the turmoil in the financial markets is far from over. New shocks will fuel the demand for the US dollar as a safe-haven currency. Based on this, we can assume that EURUSD has a place to fall.

Technically, an external Doji bar with a long upper shadow was formed on the daily chart of the main currency pair. A break of its base, where the lower limit of the fair value range of 0.967–1.006 is also located, will increase the risks of a recovery in the downward trend in EURUSD and become the basis for sales. On the contrary, the return of the euro to the upper border of the doji bar near $0.9775 is a reason to buy.