08.05.202309:13 Forex Analysis & Reviews: Federal Reserve shocked by the strong US labor market

Federal Reserve Chairman Jerome Powell stated that the US economy could avoid a recession, but the chances for this are slim due to issues in the banking sector and high inflation. He mentioned that the strength of the US labor market paves the way for a soft landing even after raising interest rates above 5%. However, with the recent labor market data, it is possible that the situation has changed.

Of course, an overheated labor market means that the Fed will have to keep rates high for a longer time to suppress inflation. That is precisely why recession risks are so high. But for this forecast to come true, the US economy will have to overcome quite a few obstacles.

In addition to high inflation, which is gradually decreasing and returning to normal, a new credit crisis looms. Most likely, the First Republic would not be the last credit institution to collapse.

A more serious problem is the slowdown in lending, which is clearly happening due to the high interest rates offered by banks. The Fed's tightening policy and recent bank bankruptcies exacerbate this process. Small businesses and commercial real estate are the ones hit particularly hard by this issue.

Another problem, but is quite solvable, is the deadlock over the issue on the debt ceiling. If the confrontation reaches its peak, the US will experience intense financial stress. Accordingly, a default in the US will greatly impact the economy. The crash could be comparable to the collapse last 2008.

The way out of all this is to lower rates. But it is difficult for the Fed to follow this as it is still trying to return inflation to the target level.

Many experts note that the fastest monetary tightening in four decades will have its price. The Fed has raised rates from nearly zero to over 5% since March last year, and in modern history, there have been no cases where such a policy did not lead to a recession.

The dynamic that leads from higher rates to a shrinking economy is simple. As the cost of borrowing rises and asset prices fall, spending slows, and businesses cut jobs. For central banks, this increase in unemployment - and, as a result, a decrease in wages - is the mechanism that returns inflation to the target level. However, now that rates are at 5.25% and the April unemployment rate has fallen from 3.5% to 3.4%, it is clear that such a scenario is not working. Thus, it will be even more difficult for the Fed to achieve a soft landing for the economy, as a much longer period of tightening will be needed before the bank could stimulate the economy and ease the monetary policy.

In terms of the forex market, euro bulls still have a chance to continue a rally. But in order to do so, the quote has to stay above 1.1030 and take control of 1.1060. This will allow a rise beyond 1.1090 and 1.1130, heading towards 1.1170. In case of a decline around 1.1030, the pair will fall to 1.1000 and 1.0940.

In GBP/USD, bulls are trying to control the market. But to see further growth, the quote has to consolidate above 1.2670 as only that will trigger a much larger rise to 1.2710 and 1.2755. In case there is a decline, bears will attempt to take 1.2630, which could lead to a fall to 1.2590 and 1.2560.