When Treasury yields rise and stock indices fall, EURUSD goes down. Reverse processes contribute to rollback. This time it was caused by events in the UK. Let us discuss the Forex outlook and make up a EURUSD trading plan.
Weekly US dollar fundamental forecast
Everything is mixed up in Forex. At a time when investors were focused on the Fed, the Bank of England decided to take the stage. The BoE purchase of bonds was a real shock to the financial markets. Provoked by a drop in the UK bond yield, the 10-year Treasury yield featured the most rapid decline since 2009. The US stock indexes have been up, followed by the EURUSD. The US dollar weakened against major world currencies. For how long?
The diverging policies of the BoE and the new conservative government shocked investors. Raising rates is aimed at suppressing demand, while tax cuts are aimed at increasing it. Fiscal stimulus should further fuel inflation, so a meteoric rally in UK bond yields should come as no surprise. It spilled over into the US market, fueling fears of a global recession, pressing down the S&P 500, and strengthening the US dollar.
There had to be some sort of a shift. Either the government should change its plan, or the BoE should sound dovish. Eventually, the BoE was ready to buy bonds for £5bn, in fact, bought for £1bn, but this was enough to provoke such a drop in bond yields in a day, which usually takes several months.
By going back to the QE, the Bank of England could trigger inflation to rise much higher. The derivatives market bets on a 6% rate hike in 2023.
Dynamics of expected BoE rate
Source: Financial Times
In the US, rising prices for Treasuries that are moving in the opposite direction of yields have been called a relief rally. In fact, there were three reasons for the rise in 10-year Treasury rates to 4%: the Fed’s aggressive monetary restriction, the fiscal expansion in the UK, and the end of the quarter when asset managers balance their portfolios. Under such conditions, the rise in the volatility of debt obligations to the maximum levels since the beginning of the pandemic looks logical.
Dynamics of price and volatility of US bonds
Source: Bloomberg
The Bank of England’s intention to suspend QT and expand QE to £65bn to calm financial markets is, of course, commendable. But can monetary expansion in a single country put an end to the Treasury yield rally? I don’t think so. At best, we expect consolidation, but certainly not a change in trend. The same goes for the EURUSD.
The Fed is not going to stop. Yes, officials have begun talking about headwinds from overseas, but according to Atlanta Fed President Raphael Bostic, the US economy and financial system are well fortified. The official expects the federal funds rate to rise to 4.25%-4.5% by the end of the year, and in this case, the US dollar will continue to dominate Forex.
Weekly EURUSD trading plan
So, the EURUSD correction is limited. If the price rebounds from the resistances at 0.979, 0.9845, and 0.9685 or goes below 0.963, it will be relevant to sell.
Price chart of EURUSD in real time mode
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