Who is to blame, and what is to be done? If the Federal Reserve's actions are not responsible for the reduction of inflation in the USA from 9% to 3%, then the Central Bank can easily lower the federal funds rate without triggering new price growth. Interestingly, in 2021, the Fed spoke of the temporary nature of high inflation. However, when the PCE started to climb higher and higher, it abandoned this idea and began to tighten monetary policy. And that idea was correct!
The fate of the U.S. dollar depends on the Fed's monetary policy. The USD index grew when the Central Bank raised rates in 2022-2023. As soon as it stopped doing so, markets began to factor in the probability of a decrease in borrowing costs, which dropped the dollar's rate in the fourth quarter. However, investors overdid it, and the rollback of chances made the USD the leader of the G10. What's next?
Dynamics of Market Expectations for the Fed Rate
There is an opinion that EUR/USD will not be able to move too far upwards from its current levels, as CME derivatives forecasts of a 130 basis points decrease in the federal funds rate in 2024 are still too high. With an 85% probability, the market expects the start of the Fed's monetary expansion in May, but this requires a significant slowdown in inflation and/or deterioration in U.S. macro statistics. FOMC members do not see this and continue to insist on maintaining borrowing costs at current levels for an extended period.
In reality, economic stimulation is already taking place through the easing of financial conditions. Stock indices at historical highs, not-so-high Treasury yields, and a not-so-strong dollar as in the fall lead to a decrease in the indicator and stimulate economic activity. The Fed is leading the States to a soft landing, but simultaneously, the Central Bank risks provoking a new wave of inflation.
Dynamics of Financial Conditions
In my opinion, a soft landing has already been achieved. But this is only an intermediate stage; it can be followed either by a cooling or a new surge in the American economy. And the scenario with an acceleration of GDP and inflation seems preferable. If so, then the strong start of the U.S. dollar is not just a temporary phenomenon. The USD index may rise for the third year in a row. Especially since in the second half of 2024, it will be supported by the factor of uncertainty due to the presidential elections in the United States.
As for the January meeting of the ECB and releases of data on American GDP and personal consumption expenditure indices, they can only rock the EUR/USD boat but not give it direction. Until the first meeting of the Fed in 2024, the main currency pair will tend to consolidate in the range of 1.085-1.100.
Technically, on the daily chart, EUR/USD is undergoing a correction to the upward trend. Until quotes return above the moving averages, the pullback risks continuing. At the same time, an unsuccessful test of the green EMA creates an opportunity to place a pending sell order at the level of the bar's low at 1.0845. This will allow for building up shorts formed on the rise of the main currency pair.