Strong US economic data could trigger a pullback in the EUR/USD pair. Rising Treasury yields, fueled by fears of spiralling inflation, will likely bolster the US dollar. Let’s discuss this topic and make a trading plan.
The article covers the following subjects:
Major Takeaways
- The US president wants one thing, but something else may happen.
- The dovish FOMC may strengthen the dollar.
- A prolonged pause by the Fed will support the greenback.
- Short trades opened at 1.1795 on the EUR/USD pair can be maintained.
Weekly US Dollar Fundamental Forecast
Donald Trump wants to see the federal funds rate at 1%, a weak dollar, and new record highs for stock indices. To achieve this, the US president wants to add more dovish members to the FOMC, led by a new Fed chair. However, the titanic efforts of the US leader may have the opposite effect.
Although the Fed controls short-term rates, its actions and expectations of those actions affect Treasury bond yields. It is these yields that determine the cost of servicing the national debt. It was these 10-year yields that Scott Bessent intended to reduce to 3% when he took office as finance minister as part of his 3-3-3 policy. The other two threes related to oil production and US GDP.
Fed Funds Rate and 10-Year Treasury Yield
Source: Wall Street Journal.
Expectations of an aggressive cut in the federal funds rate amid a strong economy could lead to an increase rather than a decrease in Treasury yields. Investors fear the risks of rampant inflation, as was the case in the 1970s. At that time, under pressure from President Richard Nixon, Fed Chairman Arthur Burns began to loosen monetary policy aggressively. This resulted in soaring prices and, subsequently, a double-dip recession in the US economy.
Stock indices and the US dollar are extremely sensitive to Treasury bond yields. Rising Treasury yields drive up costs for S&P 500 companies, reduce their profits, and cause the stock market to retreat. The greenback may strengthen as US assets become more attractive to foreign investors. This will lead to capital inflows into the United States and an increase in the USD index. During the Christmas week, it recorded its worst performance since June amid falling bond yields.
US Dollar’s Weekly Performance
Source: Bloomberg.
Thus, even if the US dollar suffers in the short term due to a more dovish FOMC, it will likely recover later. In addition, although the Fed chair has a significant influence on the FOMC, the Fed is not a one-man army.
Strong US economic data could support the US dollar, forcing the Fed to extend its pause in the monetary expansion cycle. The futures market estimates the chances of a March cut at 51%, but a shift to April will keep the yield spread between US and German bonds wide, supporting EUR/USD bears.
Weekly EURUSD Trading Plan
The greenback’s future does not look as clear as it seems due to the divergence in monetary policy between the Fed and the ECB and the narrowing gap in economic growth between the US and the eurozone. The EUR/USD pair’s pullback is likely to continue, so short trades formed at 1.1795 can be maintained.
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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