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In the second half of 2022, financial markets were driven by the hope that inflation in the United States would slow down significantly, the Fed would only need to slightly hit the brakes to return it to the target. As a result, the central bank will be able to provide the American economy with a soft landing, there will be no recession, so it's time to buy shares. And this whole scheme worked out very successfully when it became known that consumer prices slowed down from 7.7% to 7.1% YoY and from 0.4% to 0.1% MoM. Stock indices jumped like crazy, pulling EURUSD up as well.
Dynamics of American inflation
The sell-off of the U.S. dollar was facilitated not only by an improvement in global risk appetite, but also by the large-scale closure of speculative short positions on Treasury bonds. Hedge funds have accumulated record shorts since March 2020, and as soon as it became known that inflation had slowed down, they hurried to get rid of them.
A rise in the S&P 500 and falling debt yields, which are moving in the opposite direction from the price, is the perfect environment to buy EURUSD. The pair soared above 1.065 for the first time since June, finally convincing the skeptics that the downward long-term trend is broken. Even a bear like the BofA now predicts that the euro will soar to $1.1 by the end of 2023. However, it still believes that EURUSD will return to parity in the short term.
Dynamics of speculative positions on US bonds
This option is not excluded because by the end of December, inflation may present an unpleasant surprise by starting to grow again. Indeed, the price of goods is currently rapidly decreasing, while the cost of services continues to rise. In addition, the labor market is strong as a bull, and in such conditions, we should not expect a significant slowdown in average wages.
All this is well understood by the Fed, for which the improvement of financial conditions is like a bone in the throat. I believe that Fed Chair Jerome Powell will stick to hawkish rhetoric at a press conference following the December FOMC meeting. Another thing is whether this will be enough to cool the offensive impulse of the "bulls" in EURUSD?
Investors intend to look for clues from the head of the central bank about the future trajectory of rates, as well as carefully look at the updated forecast for borrowing costs. Currently, the ceiling is at 4.6%, the futures market expects it to rise to 4.9%. If, in fact, it turns out to be less, the U.S. dollar will fall into another wave of sales. On the contrary, a peak above 5.25% is fraught with a fall in the main currency pair.
Technically, on the EURUSD daily chart, there is a short-term consolidation in the range of 1.0615–1.067, which looks quite logical after such a violent rally as the day before. The Fed is called upon to disturb the bee hive. It remains for us to set two pending orders: to buy from 1.067 and sell from 1.0615. The initial targets are 1.0695 and 1.0575. Failure to overcome them will be the reason for the coup.
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