13.05.202616:49 Forex Analysis & Reviews: Traders should not underestimate US dollar

Bullish oil prospects, a stabilizing labor market, and a pick-up in US inflation — what more is needed to strengthen the greenback? The US dollar should benefit from high demand as a safe?haven asset due to the conflict in the Middle East. Indeed, the US is a net exporter of energy products. The strength of the US economy allows the Federal Reserve to consider rate hikes. Yet, EUR/USD is not rushing to fall. Why?

Bank of America believes the odds of the Fed tightening are underestimated. The futures market currently implies a 35% probability of a federal funds rate hike in 2026. Derivatives markets expect it won't happen before March next year. Investors are pricing in the Kevin Warsh factor and the view among some FOMC officials that monetary policy is already restraining economic growth. The Federal Reserve is also concerned about the simmering armed conflict in the Middle East.

Dynamics of employment, Treasury yields, and the funds rate

Bank of America is confident the markets are wrong. Yes, Kevin Warsh was appointed by Donald Trump, who has made no secret of his desire to see lower rates. If their views had differed, the president would likely have chosen someone else. But one person can't do it alone. Even if a new Fed chair advocates for softer monetary policy, other FOMC members are unlikely to support him. The Warsh factor will not prevail.

Financial and economic conditions do not indicate that monetary policy is constraining GDP growth. In Q1, real GDP rose by 2%, employment increased by 100k or more in three of the past four months, and consumer prices have accelerated to a three-year high. Add to that stock indices repeatedly setting new records, and it becomes clear the US economy is in good shape. It can withstand higher rates.

Finally, despite the conflict in the Middle East and the related rise in gasoline prices, US consumer spending has remained stable. The Fed does not need to be overly worried about geopolitics if domestic demand is holding up.

ECB forecast for the economy and inflation

The eurozone economy looks much weaker than the US. France's unemployment rate climbed to 8.1%, its highest in five years, echoing Governing Council member Olli Rehn's comments about early signs of a stagflationary shock.

In these conditions, the ECB will find it extremely difficult to tighten policy. Futures market forecasts of 2–3 deposit rate hikes may prove incorrect.

Technically, on the daily chart, EUR/USD is moving from the upper to the lower band of the fair?value range of 1.169–1.178. It makes sense to hold short positions opened from $1.178 and add to them if the single currency settles below support at $1.170 and $1.168.