The US dollar has reached its highest level since 2022 following the decline in the fed funds rate to 4.5%. However, FOMC officials have only outlined two rate cuts in their 2025 projections. Let’s discuss this topic and make a trading plan for the EURUSD pair.
The article covers the following subjects:
Major Takeaways
- The Fed signals fewer cuts than the market expected.
- Not all FOMC members agree with the December rate cut.
- US inflation may remain above 2.5% in 2025.
- The EURUSD pair is heading towards 1.03.
Weekly US Dollar Fundamental Forecast
The trading environment can be likened to a race between the US Federal Reserve and the markets. In this race, the markets often appear to be the faster runners. In a surprising move, the central bank prompted significant fluctuations in various financial instruments. The USD index has reached its highest point since 2022, stock indices have plummeted, and US Treasury yields have slumped after the Fed reduced rates by 25 bps. The central bank’s forecasts revealed that, contrary to expectations, there will be two rounds of monetary expansion in 2025 rather than three.
Monetary policy is akin to driving a car in fog. In the current environment of a cooling labor market and unexpectedly rising inflation, the Fed’s actions are similar to driving blindfolded in a car with faulty brakes. The most prudent course of action would be to stop. This is precisely what the Fed intends to do. However, its signals came as a complete surprise to investors.
FOMC Members’ Fed Funds Rate Projections
Source: Bloomberg.
In 2025, the market anticipated that the central bank would reduce borrowing costs at each of its scheduled meetings in March, June, and September. In fact, only five out of 19 FOMC officials project more than two acts of monetary expansion. The Fed revised its forecast for the personal consumption expenditures index at the end of next year, raising it from 2.2% to 2.5%. In addition, Cleveland Fed President Beth Hammack did not concur with the majority’s decision to cut the federal funds rate by 25 basis points to 4.5%.
As a result, the derivatives market underwent a shift in perspective, increasing the probability that the central bank will not lower borrowing costs at all in 2025 or will do so only once from 38% to 58%. As anticipated, the EURUSD pair experienced a significant decline.
Prior to the pandemic, FOMC officials believed the neutral rate, which neither stimulates nor cools the economy, was at 3% or lower. However, this figure has now risen to nearly 4%, indicating that the Fed’s monetary easing cycle is nearing its conclusion.
Fed Estimated Neutral Rate
Source: Wall Street Journal.
In contrast to the Fed, which is poised to halt its cycle, the European Central Bank (ECB) has no plans to do so. At least for the next two Governing Council meetings, the deposit rate will decline. Its differential with the federal funds rate will widen further, severely harming the EURUSD pair. Markets are rising on expectations, so it is not surprising that the major currency pair is plummeting.
Weekly EURUSD Trading Plan
The EURUSD pair is approaching the bearish target of 1.03, with parity on the horizon. This is positive news for those who opened short positions on the pair at 1.121 and 1.0615. Therefore, short trades can be kept open, and one can initiate more of them on pullbacks.
Price chart of EURUSD in real time mode
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.
Discussion about this post