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The banking crisis has done some of the work for the Fed. Even Jerome Powell admitted that the series of bankruptcies has the same effect on the economy as raising the federal funds rate. Financial conditions tighten, lending declines, GDP slows, and inflation cools. Thus, cracks in the banking system allow the Fed to get closer to the finish line in the monetary restriction process. And this circumstance has inspired the EURUSD bulls to attack.
The proximity of the federal funds rate to its peak is evidence that the best days of the U.S. dollar are behind us. Even though Powell stressed several times that there will be no easing of monetary policy in 2023, the futures market lays down expectations of a reduction in the cost of borrowing by 65 bps. In such conditions, those currencies whose central issuing banks do not think to stop monetary restriction usually benefit the most. For example, the pound, thanks to an increase in the repo rate to 4.25% amid an unexpected surge in inflation.
Dynamics of Central Bank Rates
The same is true for the euro. ECB officials maintain their hawkish rhetoric, which raises the implied borrowing cost ceiling from 3.2% to 3.5%. And that's not the limit yet. Bundesbank President Joachim Nagel believes that the eurozone must be persistent and continue the monetary tightening cycle to fight inflation. It is not over yet. If the European Central Bank wants to tame these stubbornly high prices, it must be even more stubborn. ECB President Christine Lagarde said the effects of the monetary restriction are just beginning to hit the currency bloc's economy, and signs that inflation will remain high are forcing the European regulator to raise borrowing costs to restrictive levels as quickly as possible.
Thus, the U.S. economy risks continuing to cool down under the influence of the banking crisis, the Fed weighs whether to stop the cycle of tightening monetary policy or take another 25 bps step, while the ECB remains resolute amid the greater stability of the European banking system compared to the U.S. Why would EURUSD not grow in such conditions? What can stop euro fans? Is it the cold weather in the eurozone, which, recently, was associated with an energy crisis?
Temperature dynamics in Europe
I don't think that this factor will have much impact in the spring as it did in the winter. Ultimately, we are talking about different temperatures. The euro, most likely, got scared of its own agility, and some "bulls" in the main currency pair preferred to fix profits on long positions after a rough EURUSD rally. But this is not to say that it is over.
Technically, the first target at $1,089 on longs was met very quickly. The pullback provides an excellent opportunity to increase euro purchases towards $1.103.
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