Everyone knows that markets rise on expectations and fall on facts. History shows that over the last four cycles of the Fed's monetary tightening, the U.S. dollar has fallen 4% on average, while steadily strengthening in the 9 months before the first increase in the federal funds rate. In the case of the cycle that the Fed started on March 16, the USD index rose by 7%. Is it time to fall?
At the last meeting, the FOMC raised its forecast for the federal funds rate to almost 1.8% in 2022 and 2.8% in 2023. The central bank is ready to tighten monetary policy at every meeting this year and intends to exceed the neutral level of 2.4% to bring inflation to its knees. However, even such an aggressive monetary restriction did not impress the financial markets. U.S. stock indices rose, the dollar weakened. It seems that the divergence in monetary policy is fully taken into account in the EURUSD quotes, which allows us to say that the story of the weakening of the U.S. currency during the Fed's rate hike may repeat itself.
Indeed, U.S. Treasury yields and interest rate swap rates have risen so rapidly of late that they would do well to halt and hand the pitch over to their European counterparts. The ECB pretty much surprised the financial markets in March by deciding to end QE ahead of time and hinting at a rate hike. Why shouldn't investors start buying euros?
Dynamics of EURUSD and interest rate swap differential
It cannot be said that the divergence in monetary policy is the only driver of the EURUSD peak, which allowed the pair to reach 1.08. In fact, events in Ukraine had a hand in its fall. Europe is much closer to the epicenter of armed conflict than the U.S.; it is more dependent on Russia than the U.S. and is a net importer of energy products. The eurozone economy will obviously suffer more in the first half of the year than the U.S. economy, but in the second half, the cooling of the latter and the recovery in the eurozone may open the door for the euro to rise against the U.S. dollar.
Let's not forget about geopolitics. The demand for safe-haven assets associated with it has become one of the key trump cards of the "bears" in EURUSD. The U.S. dollar strengthened due to uncertainty, it has not disappeared, however, the risks are gradually shifting from military operations to diplomacy, and only a new escalation of the armed conflict can return the quotes of the main currency pair to 1.08. Otherwise, we expect medium-term consolidation in the range of 1.09-1.13, followed by a breakout and a hike to 1.15 before the end of this year.
Technically, the formation of the 1-2-3 reversal pattern is a wake-up call for the "bears" in EURUSD. If the pair does not fall below 1.1 in the next couple of days, the likelihood of a correction to a long-term downward trend will increase. The reason for buying the euro against the U.S. dollar in the direction of 1.125 and 1.13 will be a break of resistance at 1.113. On the contrary, a successful assault on support at 1.1 is a signal for the formation of short positions on EURUSD with a target at 1.095 and 1.088 as part of the implementation of Linda Raschke's "Holy Grail" strategy.
EURUSD, Daily chart