As expected! The market was overly confident about the US central bank's dovish pivot this year when Federal Reserve Chairman Jerome Powell allowed it to form its own opinion. Derivatives gave almost a 90% chance of a federal funds rate cut at the FOMC meeting in July. The odds of it falling from 5.25% to 5% in June were 50-50. This put significant pressure on the US dollar. However, the US labor market report taught EUR/USD a lesson.
Employment growth outside the agricultural sector by 230,000, which is significantly higher than the 160,000 expected by Bloomberg experts, a decrease in unemployment from 3.5% to 3.4%, and an acceleration in average wages from 4.3% to 4.4% convince that the labor market is firmly standing. If so, inflation is more likely to accelerate than slow down. The Fed is more likely to keep the federal funds rate at 5.25% until the end of 2023, as predicted. And the futures market was wrong.
Dynamics of market expectations for the Fed rate
Danske Bank held this opinion even before the release of the April employment report. It predicted a drop in EUR/USD to 1.06 in 6 months. And now this assumption does not seem like something great. Nordea believes that the Fed will lower borrowing costs for the first time only in June 2024. Due to the large-scale fiscal and monetary stimuli of 2020-2021, the US economy is very resilient and capable of withstanding even the most aggressive tightening of the Fed's monetary policy in decades.
The only thing that can change the rules of the game is a serious economic shock. Perhaps it will be a default due to Congress's unwillingness to raise the debt ceiling. But the most likely source of ignition appears to be the banking system. Although after the problematic First Republic was absorbed by the giant JP Morgan, it seemed that the crisis had ended, in reality, this is not the case. The collapse of shares of regional credit institutions PacWest, First Horizon, and Western Alliance on May 4th trading convinces that the problem is not solved.
The situation is increasingly reminiscent of 2008 when the massive bankruptcy of American banks triggered a global economic crisis. Indeed, it was about problematic loans. Now the issue is the outflow of deposits. In trying to save money, banks raise deposit rates. This reduces the profitability of credit institutions and contributes to the fall in stock quotes. As a result, issuers find it more difficult to attract shareholder capital.
No matter how events develop, the labor market report has proven that it is too early to write off the US dollar. It will still fight. Especially if US inflation unexpectedly accelerates in April. The consumer price report will be the key event of the week leading up to May 12th.
Technically, on the daily chart of EUR/USD, bears are playing out the Double Top pattern. Breaking the fair value at 1.097 will make it possible for us to build the shorts formed earlier in the day from the 1.1 level. Targets are set at 1.089 and 1.084.