While the Fed may view high inflation as a transient issue, the ECB sees it differently. It has no intention of waiting any longer. Monetary tightening is just around the corner, boosting the EUR/USD pair. Let's discuss this topic and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- Hostilities ahead of the peace agreement are rattling the markets.
- The Fed may shift its focus to the trimmed-mean inflation rate.
- The ECB seems ready to take decisive action.
- It would be prudent to refrain from trading the EUR/USD pair.
Weekly Euro Fundamental Forecast
If the 60-day ceasefire agreement is violated just as the current truce has been, what is the point of it? Iran shot down an American drone flying over international airspace. In response, the US struck air defense systems and a command center, prompting an attack by Iran on its own base. Meanwhile, the EUR/USD pair opened the week with a gap down, though it was not large enough to deter bulls from resuming the uptrend.
The US and Iran are exchanging proposals to adjust the terms of the agreement. There is a risk that if one side rejects the terms, the agreement will fail. However, the base case for the markets is that it will be concluded. The exchange of strikes contradicts this, so the jittery reaction of EUR/USD quotes seems logical. The euro is both eager and hesitant to move higher.
As soon as geopolitics ceases to be the main driver on Forex, investors will refocus on central banks and inflation. The key question is whether the inflationary surge linked to tariffs, investments in artificial intelligence, and the oil crisis will be temporary. Or will high prices become firmly entrenched in the economy for the long term? The Fed's actions and the future of dollar pairs depend on the answer to this question.
US Inflation Change
Source: Bloomberg.
When making decisions, the Federal Reserve looks at the Personal Consumption Expenditures (PCE) index. In particular, it focuses on the core PCE, which excludes the impact of energy prices. However, if we consider the so-called trimmed-mean inflation, the disinflationary trend continues. The central bank can afford to cut rates, as the US administration desires.
As research by the Dallas Fed shows, the trimmed mean inflation measure has performed well across most time periods, enabling the Fed to make well-considered decisions on interest rates. However, it failed in 2021, when the central bank called the surge in PCE "transitory" and was then forced to implement the most aggressive monetary tightening in four decades.
Inflation in Europe
Source: Bloomberg.
If Kevin Warsh succeeds in persuading the FOMC to embrace the notion of transitory inflation, EUR/USD quotes may rally sharply on expectations of a more accommodative Federal Reserve policy stance. This would create a policy divergence, as the ECB is increasingly considering rate hikes amid accelerating inflation across the eurozone's largest economies.
According to Isabel Schnabel, the Governing Council must move toward monetary tightening, as rising energy prices are increasingly feeding into core inflation. The ECB can no longer afford to remain on the sidelines as the inflationary effects of the energy shock continue to spread across the economy.
Weekly EURUSD Trading Plan
If the conflict in the Middle East ends, it will likely trigger a rally in the EUR/USD pair. However, until that happens, it may be prudent to remain on the sidelines.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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