In November, the markets lost their reason. In December, enlightenment is coming to them. What talk can there be about a 125 bps reduction in the federal funds rate to 4.25% when the U.S. economy is growing at 5.2%, and inflation at 3.5% is still far from the target? Moreover, central banks never tire of repeating that the last mile of fighting high prices is the most challenging. Has the S&P 500 climbed too high? Isn't it time for it to experience dizziness and fall, dragging EUR/USD down with it?
The situation with the eurozone looks much more logical. Its GDP is balancing on the brink of recession and stagflation, and the 3.7% decrease in German manufacturing orders in October indicates that Germany has not yet emerged from the pit. Meanwhile, inflation in the currency bloc has slowed to 2.4%. It is not surprising that the futures market believes that the mass easing of monetary policy will begin with the ECB.
Dynamics of German Production Orders
And let the officials of the Governing Council try to dissuade the markets from their dovish reversal idea; investors do not believe them. They practically ignored the words of the head of the Bank of Latvia, Martins Kazaks, who stated that the deposit rate would not be lowered for the next six months if conditions do not change. Derivatives are fully confident in the end of the cycles of monetary restrictions, and a decrease in the cost of borrowing will follow in any case.
The assessment of the potential easing of the ECB's monetary policy is going faster in early December than that of the Fed. This is why EUR/USD could not consolidate above 1.1 and collapsed from the area of 3.5-month highs. According to ING, the euro may fall to $1.05 by the end of December next year, as the rate cuts by both the Federal Reserve and the European Bank will be slower than the futures market currently assumes. Washington will reduce the cost of borrowing by 50 bps and Frankfurt by 50 bps.
Dynamics of Market Expectations for ECB and Fed Rates
This circumstance will weaken global risk appetite and increase demand for the U.S. dollar as a safe haven. The growing political rating of Donald Trump could expedite the process, increasing the risks of his victory in the 2024 presidential election and the likelihood of a resumption of the U.S.-China trade war. In 2018-2019, it contributed to the strengthening of the dollar against major world currencies.
It's likely that only the restoration of the upward trend in the S&P 500 will allow EUR/USD to recover. If U.S. stock indices fall, the rise in demand for safe harbors and divergence in monetary policy will put pressure on the main currency pair.
The technical inability of EUR/USD to return to the trading range of 1.08-1.1 indicates the weakness of the bulls. As long as the euro is trading below $1.08, emphasis should be placed on sales, and short positions formed from the level of 1.094 should be increased. Only a rise in the main currency pair above 1.08 will prompt a departure from this strategy and a shift to medium- and long-term longs.