Fundamental analysis

EUR/USD: Fed hints at a slowdown in the pace of policy tightening, but the market doubts that the dollar’s cards are beaten

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Following the results of Wednesday’s trading, the greenback strengthened against its main competitors, including the euro.

The day before, investors were evaluating the results of the Federal Reserve’s November meeting.

The USD index ended Wednesday’s session with an increase of more than 0.7%, reaching the highest values for the week in the area of 112.00 points.

“It’s really about the “dollar smile” that maintains the greenback whenever the Fed leads the fight against inflation – it’s one of the most, if not the most hawkish, central bank in the world. In addition, the Fed’s actions fuel risk aversion. And the current dynamics of USD is a vivid example of how these two forces work in tandem,” Credit Agricole strategists noted.

Wall Street’s key indicators initially rose following the Fed’s 75 basis point increase in the key rate, the fourth consecutive increase in the cost of borrowing of this scale.

Market participants welcomed the central bank’s signals that there may be smaller rate hikes on the horizon.

“When making decisions about the future pace of raising the target rate range, the Fed will take into account the cumulative effect of tightening monetary policy, as well as the fact that rate changes affect economic activity and inflation with a delay,” the US central bank said in its final communique.

However, comments by Fed Chairman Jerome Powell destroyed the initial optimism.

The Fed may go different ways in its future policy, but at some point the central bank will have to slow down the rate hike, said Powell at a press conference.

“The time for this may come in December,” he said.

At the same time, Powell noted that it is too early to talk about a pause in the rate hike.

In addition, he said, they still had not decided on how high the rates should be in order to curb inflation, and were determined to stick to the planned course until the work was done.


Traders took Powell’s comments as a hint of a higher than expected peak rate back in September.

The futures market for the federal funds rate has confidently forecast a ceiling above 5% per annum.

Also, Powell said the window for the so-called “soft landing” has narrowed.

The American economy has slowed down significantly compared to last year’s level, with inflation remaining high and the labor market strong.

“In order to achieve a slowdown in inflation, a steady period of economic growth at a pace below trend will be required,” said Powell.

Powell’s comments contributed to the strengthening of the dollar against its main competitors.

Meanwhile, the leading US indices erased their initial growth after Powell’s speech and ended the day with a sharp decline. In particular, the S&P 500 fell 2.5% to 3,759.69 points.

After a strong rally in October, when the S&P rose by about 8%, three key Wall Street indicators did not fall for three consecutive sessions. Wednesday’s decline was the biggest percentage decline in the S&P 500 index since October 7.

Some experts believe that a sustained reversal in the markets is unlikely to occur until there are clear signs that the Fed has cooled inflation and decidedly slowed economic growth.

“Every time there is a rally in the stock markets, we talk about the need to continue to take a defensive position. Thus, we still remain in a defensive position with regard to stocks, especially after Powell’s press conference,” BlackRock strategists noted.

Indeed, encouraging rallies followed by rapid reversals are a characteristic feature of this year, during which the S&P 500 jumped 6% or more four times only to turn around and reach a new low. The index has decreased by 21% since the beginning of the year.


FS Investments analysts believe that even after the Fed finishes raising rates, it is likely to slowly lower them, which means that months and quarters may pass before it makes sense to buy risky assets intensively.

“The Fed wants tighter financial conditions, it always gets what it wants,” they said.

Of course, a lot can change between now and the Fed’s December meeting.

In the coming week, a monthly report on consumer prices in the United States will be published, which may become an important turning point for the markets.

Evidence that inflation is starting to slow down after a flurry of Fed rate hikes may strengthen the case for a less aggressive monetary policy in the coming months.

Signs of a less hawkish Fed policy may provoke a decline in the USD rate by 1-2%, but such a step is likely to be short-lived, according to Jefferies.

“The Fed will continue to raise the key rate, and it is still one of the highest in the G10,” said analysts at the bank, who expect the dollar to continue to strengthen until the end of the year.

Powell’s current message to the markets seems to be the following: do not count on the fact that the central bank will raise the rate by 75 bps every time. However, this does not mean at all that the US central bank is close to completing the rate hike cycle. They will rise more slowly, but longer and higher than previously thought.

While the accelerated rate hikes this year were made in the name of moving quickly to catch up with inflation more than three times the Fed’s 2% target, the central bank is now entering a more subtle phase and will be fine-tuning instead of bootstrapping.


The Fed is moving to plans for a slower but longer cycle of rate hikes, economists at MUFG Bank believe.

In their opinion, the increase in expectations regarding the terminal rate as part of the Fed’s increase cycle will serve as a tailwind for the dollar until the end of the year.

“The money market is now assessing a 62 bps rate hike at the December FOMC meeting, as it is trying to understand whether the Fed will hold the last 75 bps rate hike this year or move to a 50 bps hike,” MUFG Bank analysts noted.

“Powell’s latest comments signal that the Fed is moving towards plans for a slower but longer rate hike cycle. Rising market expectations for the Fed’s final rate support our forecast for even more dollar strength through the end of the year,” they added.

Even if the Fed slows down the pace of monetary policy tightening, it may encourage other central banks to do the same, which will allow the United States to maintain a relatively higher yield, which will support the appeal of the greenback, according to UBS.

“If the Fed pulls back, it will allow other central banks to pull back as well,” said the bank’s strategists, who expect the dollar to strengthen further in the coming months.

“We think it’s too early to talk about the USD peak. Inflation in the US remains too high, the Fed sees that its own credibility is under threat, and we believe that it will continue to aggressively raise rates until official inflation figures take a breather,” UBS said.


The bank predicts that the dollar will continue to strengthen in the fourth quarter before peaking in the first quarter of next year, which is when investors will begin to assess the end of the cycle of interest rate hikes in the United States.

“We believe that in the coming months, the EUR/USD rate will fall below 0.9000, and then rebound to 0.9600 at the end of March 2023, if, as we expect, the Fed signals a pause,” UBS analysts said.

There are factors that can damage the bullish mood of the dollar. Signs of a rapid decline in US inflation or a sharp economic downturn could undermine the case for tightening monetary policy and potentially put pressure on the dollar.

“If the tightening of policy turns out to be excessive, the Fed may take measures to support the economy,” said Powell.

So far, the greenback continues to benefit from investors’ withdrawal from risk, as the US central bank has again dispelled hopes for a dovish turn in policy.

On Thursday, the dollar added more than 1% to the previous day’s achievements and reached almost two-week highs, coming close to the barrier of 113.00.

“A rebound to October highs in the area of 113.50-113.90 is not excluded. Recovery above this zone is necessary to confirm the next stage of the uptrend. The July peak at 109.30-109.00 is a decisive support in the near term; only a break below will mean a deepening of the downtrend,” Societe Generale economists believe.

Reflecting the weak investor sentiment towards risk, the leading Wall Street indexes mostly declined on Thursday.

The S&P 500 is losing about 0.5% amid concerns that the US interest rate hike cycle is far from over, despite hints from the Fed that the pace of policy tightening will slow down in the future.

“The S&P 500 has witnessed an aggressive sell-off on increased volume since the high of the end of September, a descending 63-day average and a 50% correction of the fall since September at the level of 3902-3912. The scale of the pullback and the breakthrough of short-term support at the level of 3804 confirm our opinion that the recent growth was just another rally in the bear market”, Credit Suisse analysts noted.

“The nearest support is at 3751 (the 38.2% Fibonacci retracement level of the October-November rally). In case of a breakthrough to the downside, a fall to the support is expected, which is located at the low of the end of October 3652-3647, and then a retest of the key 200-week average at the level of 3620-3619. The initial resistance is observed at the level of 3802-3804, and then at 3840. At the same time, the 3894-3912 zone will remain the main barrier,” they added.

Amid the continuing fall of key Wall Street indicators and the strengthening of the dollar with a broad front, the EUR/USD pair breaks through the support level of 0.9800 and sets new two-week lows around 0.9730 on Thursday.

The main currency pair is on its way to testing the October 21 low near 0.9705, and then the October 13 low near 0.9635, Brown Brothers Harriman strategists say.

“Given that most of the eurozone is likely already plunged into recession, will the ECB be able to raise rates as aggressively as expected? It seems that the market is starting to doubt this,” they said.


“It will be difficult for the ECB to fight with a higher level of the Fed’s final rate. We strongly doubt that the ECB will be able to raise its own estimates of the final rate so high,” TD Securities analysts said.

On Thursday, European Central Bank board member Fabio Panetta said that the eurozone is more vulnerable than the United States to a global economic downturn and rising energy prices, and that the tightening of the Fed’s policy is already taking effect, which means that the ECB needs to be cautious.

According to him, the ECB should avoid raising interest rates too quickly, as this could cause excessive damage to economic growth, housing prices and financial markets.

“If these larger-than-expected increases are interpreted as a signal of a higher final rate, and not just the beginning of normalization, we may have a stronger impact on financing conditions – and, ultimately, on economic activity – than expected,” said Panetta.

The head of the Bank of Italy, Ignazio Visco, in turn, said that the ECB should not be expected to react in the same way as the Fed, and supported market expectations of lower rates in the eurozone than in the United States.

His colleague from Portugal, Mario Centeno, went even further, saying that the ECB has already completed most of the rate hikes, which, in his opinion, are necessary after an increase of 200 basis points since July.

These comments only added fuel to the fire of the decline of the EUR/USD pair.

“Closing below the uptrend since the end of September at 0.9766 should lead to maintaining a negative tone and testing the 0.9708-0.9704 area. Below the October low of 0.9636-0.9634, confirmation of the resumption of the main bearish trend is probably needed to return to the September low of 0.9537 and eventually, as we believe, to 0.9338-0.9330,” Credit Suisse analysts said.

“The initial resistance is at 0.9840, and then at the 55-day moving average near 0.9890. However, to confirm the positive tone, the pair needs to return above 0.9977,” they added.

The material has been provided by InstaForex Company –