As expected, a faster decline in US consumer price growth in March was the catalyst for the EURUSD rally. The pair came within arm's reach of the psychologically important level of 1.1, due to investors' belief that the rate hike in May will be the last one and the Federal Reserve will finally be done with monetary tightening. If that comes true.
For the first time in over two years, consumer prices in the US are growing slower than the core inflation. In March, CPI slowed down from 6% to 5% due to the effect of a high base. A year ago, soaring energy prices triggered a mechanism to accelerate inflation. In June 2022, it peaked, and comparisons with those times suggest that in the coming months, the pace of consumer price growth will drop to 4% and below.
US inflation
The recovery of the services sector from the pandemic and the still strong labor market will certainly put a damper on the process, but disinflationary phenomena in the U.S. real estate market, economic slowdown, and the resolution of supply chain issues suggest that the peak of inflation is behind us. The indicator is steadily moving towards the 2% target, which means it's time for the Fed to wrap up its work. According to Philadelphia Fed President Patrick Harker, the peak borrowing cost is slightly above 5%.
After the March inflation report, Treasury bond yields fell, the US dollar weakened, and the chances of a quarter point rate hike in May dropped from 72% to 66%. Such an outcome is most likely, while investors are looking for clues about the Fed's future actions in the minutes of its March meeting.
For now, derivatives are clinging to the idea of a dovish pivot. They predict that borrowing costs in the US will fall by 40-50 basis points by the end of the current year.
Dynamics of expectations for the Fed rate
In my opinion, the Fed may abandon its idea of keeping rates at a plateau for an extended period of time in only one case. If the US economy begins to wither before our eyes. Fed Chairman Jerome Powell and his colleagues weren't usually bothered by the approach of a recession. But now times have changed. The IMF believes that inflation will slow down due to sluggish GDP growth.
Thus, if we receive even worse US macro data in the future, the more chances there are for the Fed to ease its monetary policy as early as 2023. If the US economy gets a second wind, the dollar may return to the game.
Technically, on the daily chart, EURUSD bulls have taken another step forward in reviving the uptrend. In accordance with the target at 161.8% for the AB=CD trading pattern, the initial target level is 1.133. You should buy euros on pullbacks and on breakouts of important pivot levels.