A voice crying out in the wilderness. That's how one can characterize JP Morgan's statement that the markets are correct about lowering the federal funds rate in 2023. They argue that the U.S. economy is rapidly cooling, and recession is inevitable. To mitigate its negative impact, the Federal Reserve will be forced to loosen monetary policy. Such arguments were popular back in late April when EUR/USD rose to annual highs. Unfortunately, strong U.S. employment and retail sales data changed the balance of power in the major currency pair.
Only 5 of the 27 Bloomberg experts claimed that United States would not face a downturn in the next 12 months. Nonetheless, the timing of the presumed recession keeps getting pushed back. Unlike JP Morgan, Goldman Sachs and Barclays assert that the Fed will hold the Federal Funds rate at peak for a very long time. This implies a rise in Treasury bond yields and a strengthening of the U.S. dollar.
Dynamics of the Federal Reserve Rate and U.S. Treasury Yields
This is precisely what is happening at the moment. EUR/USD is falling rapidly due to the increased likelihood of a 25 bps rise in the Federal Funds rate in June to 27% and reduced chances of monetary expansion in September to 52%. Before the April U.S. employment report, the first figure was close to zero, the second was at 90%. Is it any wonder the main currency pair is correcting?
As for default, opinions about the dollar's reaction to such an event are mixed. Some speak of the strengthening of the dollar as a safe-haven currency. Others argue that the U.S.'s inability to pay its obligations will result in a recession and a fall in the USD index. In my view, the most appropriate response would be to look at the experience of 2011. Then, the debt ceiling was not raised until the X date, leading to a crash in U.S. stock indices and a sharp rise in gold.
Market Reaction to the U.S. Debt Ceiling Deadlock in 2011
At the same time, both the dollar and U.S. Treasury bonds reacted rather calmly. Yes, the Republicans and Democrats, frightened by the financial market panic, were able to come to an agreement within a few hours. But who said that in 2023 they won't do this before the X date? Investors are accustomed to happy endings and are not overly nervous about a potential default. No matter how much Treasury Secretary Janet Yellen may scare them with a 45% crash of the S&P 500 and the loss of 8 million jobs.
Thus, the market continues to reject the idea of the Federal Reserve's dovish pivot in 2023. It was taken into account in the quotes of the main currency pair, so the correction of EUR/USD seems logical.
Technically, the bears in EUR/USD perfectly played out the Double Top reversal pattern. They are completely dominant in the market and will continue to do so as long as the quotes are below the moving averages. Sales strategies from 1.101, 1.089, 1.086 and 1.084 are working like clockwork. We hold shorts, at least, until 1.076.