If the economy is growing thanks to artificial intelligence, and high interest rates could seriously undermine AI development, why tighten monetary policy? Kevin Warsh has left markets questioning the Fed’s next move. Let’s discuss this topic and make a trading plan for EUR/USD.
The article covers the following subjects:
Major Takeaways
- The Fed held interest rates steady, with two dissenting votes.
- Kevin Warsh believes inflation will not accelerate.
- Derivatives markets have lowered the odds of further rate hikes.
- EUR/USD’s next move depends on the ECB and US GDP data.
Fundamental Forecast for the Dollar Today
Will the federal funds rate rise? Markets received no clear answer to this crucial question. On the one hand, Kevin Warsh said inflation remains elevated, financial conditions are not sufficiently restrictive, and the Fed’s work is not done. On the other hand, he noted that monetary tightening hurts the AI industry, which has been driving economic growth. Why undermine the very force supporting the economy? EUR/USD reflected this view, rebounding from a 17-month low.
A strong economy does not necessarily lead to accelerating inflation. Kevin Warsh challenged the theory that robust economic growth is incompatible with low inflation. The Fed chair believes that productivity gains, primarily driven by AI, can allow the economy to grow faster without triggering an inflation surge. At the same time, AI companies are particularly sensitive to higher interest rates because they rely heavily on borrowed funds. Excessive monetary tightening could bring the entire structure crashing down. The stock market bubble could burst, leaving the economy without its main growth driver. Is that a risk the Fed should take?
Market Expectations for the Fed Funds Rate
Source: Bloomberg
Markets decided it was not. They still expect a federal funds rate hike in December, but the probability of three rate hikes over the next 12 months has fallen from 67% to 58%. Two-year Treasury yields, which are sensitive to monetary tightening, declined, while 10-year yields rose. The moves followed Kevin Warsh’s statement that fighting inflation should not mean bringing economic growth to a halt.
Actual and Expected Fed Funds Rate
Source: Bloomberg
In my view, Kevin Warsh has finally shown his hand. He genuinely believes that artificial intelligence will boost productivity, allowing the economy to grow faster without fueling inflation. This position suits the White House, as Scott Bessent’s comments suggest. The Treasury secretary believes the Fed can balance unemployment and inflation. At the same time, the new Fed chair’s views appear to have support within the FOMC. Otherwise, there would have been more dissenting votes.
One problem remains: the conflict in the Middle East shows no signs of ending. This means that the rise in core inflation driven by energy prices may not be nearly as temporary as the White House, and probably Kevin Warsh himself, would like to believe. However, only the next CPI report can confirm this. Until the report is released, the US dollar is likely to remain influenced by the outcome of the October FOMC meeting.
EUR/USD Trading Plan for Today
If EUR/USD bulls can withstand the challenges posed by a cautious ECB and accelerating US GDP growth, we can expect a rebound and buying opportunities targeting 1.12 and 1.13. Otherwise, the euro could plunge toward $1.109 and $1.1055.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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