The Fed could provoke the S&P 500 correction in an attempt to stem rising inflation by reducing the growth rate of the money supply. How will this affect EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Fundamental US dollar forecast for a week
When everyone is making purchases, there is a great opportunity to sell. It is not in vain that major traders use news to form positions. The crowd, frightened by the disappointing statistics, will give them their money. It doesn’t matter what little thing caused the fear. Let it be an increase in core inflation of +0.3% against the forecast of +0.4% MoM. One tenth of a percent pushed the EURUSD price from the bottom to the middle of the 17th figure, allowing USD buyers to purchase it at an attractive price.
The slowdown in consumer prices from 0.9% to 0.5% MoM and the core CPI from 0.9% to 0.3% in July prompted the markets to believe that the series of excessive inflationary surprises was over. However, is the period of increased inflationary pressures over? The decline in the growth rate of the base CPI from 4.5% to 4.3% YoY is the same as a drop in body temperature from 39 to 38.5 degrees. It seems less, but still hot.
Inflation dynamics in the USA
Source: Bloomberg.
Yes, price pressure in leading sectors, including used car sales, is on the decline. But new ones are ready to replace the old growth drivers. For example, rent, the share of which in PCE is about 30%, or the average hourly wage, which increased by 5% in May-June. And if you remember the large amount of money that consumers got from the fiscal stimulus, it becomes clear that high inflation is serious and long-lasting.
Of course, the Fed is doing everything possible to prevent its acceleration. The central bank has a lot of experience in fighting the last recession, when it managed to stop the rise in consumer prices with the help of loans in the form of reverse interest rates. The volume of such transactions is now rapidly increasing, which leads to a slowdown in the growth of the money supply. However, in the economy, everything is interconnected. An attempt to slow down inflation can have dire consequences for the stock market. For the first time since 2018, the US GDP rate is faster than the M2 money supply. The ratio is known as the Marshallian K. Its movement to the red zone in 2010 led to the S&P 500’s 16% correction, and nearly broke a bullish stock market in 2018.
Dynamics of the S&P 500 and the Marshallian K
Source: Bloomberg.
Lack of liquidity is indeed capable of provoking a correction in stock indices, which will boost demand for such a safe-haven asset like the US dollar.
Meanwhile, despite the slowdown in core inflation, FOMC officials say it is necessary to taper QE. Kansas City Fed President, Esther George, believes today’s economy is signaling that it’s time to get back to old ways. Dallas Federal Reserve Bank head, Robert Kaplan, calls for the start of the withdrawing of monetary stimulus in October. Even such a “dove” as the boss of the Federal Reserve Bank of San Francisco, Mary Daly, spoke about reducing the scale of asset purchases in late 2021 or early 2022.
Weekly EURUSD trading plan
I very much doubt that the ending of the excessive inflationary surprises was a game changer. The Fed intends to act faster than the ECB, the US economy is ahead of the European one, which means EURUSD downtrend will continue. Use the rebound from the resistances at 1.1775, 1.18 and 1.184 to enter short trades.
Price chart of EURUSD in real time mode
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.
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