This morning at 8:30 am Eastern Time, the Bureau of Labor Statistics revealed the latest figures for a key measure of inflation in the United States. The Producer Price Index (PPI), which tracks changes in the prices of goods and services sold by producers, was expected to increase by 0.4% month-over-month in October; instead, it only rose by a mild 0.2%. Likewise, Core PPI (which excludes volatile food and energy prices), was forecast to increase by 0.3% month-over-month, but remained static, changing exactly 0% instead. These surprising PPI numbers today offer yet another instance of American inflation dropping following the recent low CPI report, building a bearish case for USD and a bullish one for stock market indices as the need for a hawkish Fed ostensibly lessens. However, I am personally skeptical of this development as many underlying economic fundamentals have not changed, as we will discuss below.
Markets to Watch
My bias remains bullish on USD, and bearish on the US stock market, for three primary reasons: A) None of the crises the world is contending with have evaporated: an energy crisis still looms with winter around the corner, and many markets are still hot with artificial demand following quantitative easing mid-pandemic. B) The Democratic Party in the US, which tends to be seen as a pro-stimulus party, recently outperformed expectations in last week’s midterm elections, which I predicted could create short-term rallies in the stock market (but longer-term bullishness for USD). C) One month’s worth of data on inflation is not enough to mark a trend; October’s low numbers could easily be outliers, perhaps due to tapping into oil reserves to alleviate cost-of-living increases.
For those who remain bullish on USD and anticipate the Fed further hiking interest rates at a historic pace to quell high inflation, the following markets will be key to watch. They are listed below with their respective EdgeFinder ratings, signals/biases (which diverge from mine), and corresponding charts.
1) EUR/USD (Receives a -2, or ‘Neutral’ Signal)
2) US30 (Receives a 4, or ‘Buy’ Signal)
3) USO (Receives a -5, or ‘Sell’ Signal)
The US Dollar Index (DXY) has surged this morning, up over 0.9% intraday as buying pressure pushes it above the 109 level for the first time in two decades. Yesterday, the Bureau of Labor Statistics revealed that month-over-month CPI in June clocked in at 1.3%, whereas 1.1% had been expected. This means that year-over-year inflation has hit 9.1% in the United States, identical to that in the United Kingdom, tied for highest among the G7 countries. Likewise, even Core CPI, which excludes volatile food and energy prices, reached 0.7% month-over-month in the US, whereas only 0.5% had been anticipated. This is extremely bullish for USD and reflects as such among the major pairs; in fact, it has even prompted EURUSD to briefly plunge below parity support today, testing the 0.995 level for the first time in 20 years. While it would be easy to pin this momentum entirely on demand for USD, in terms of fundamentals, the story is even more bearish for the pair than these new numbers indicate. Let’s juxtapose these two currencies’ circumstances as we engage in a newly revived discussion, the significance of which is huge: making sense of EURUSD parity.
USD Strength Factor #1: Holistic Hyperinflation
The US economy continues to overheat as sustained inflation accelerates. This may seem trivial considering how ubiquitous this phenomenon is; after all, even if the US is tied for the highest inflation rate in the G7, aren’t the countries’ inflation rates comparable enough, and their supply chains mutually globalized enough, that the exact numerical differences would be irrelevant? However, when we sift through the details, inflation in the US is particularly robust and nuanced.
In spite of a slight uptick in unemployment claims, the American labor market remains especially hot: high NFP numbers, a historically low 3.6% unemployment rate, and millions of unfilled job openings signal economic vitality, feeding strong demand. Likewise, US monthly goods trade deficits are hitting record numbers, consecutively surpassing $100 billion despite USD’s high value relative to other currencies; even Core CPI is beating market forecasts by big margins. These all signal strong US consumer spending that will continue into the near future, feeding inflation.
USD Strength Factor #2: A Hawkish Federal Reserve
The Federal Reserve, the United States’ central bank, has come a long way from the dovish institution that was dishing out monetary stimulus throughout the pandemic. Gone are quantitative easing and near-zero interest rates, replaced by quantitative tightening and steadily growing rate hikes. The Federal Open Market Committee (FOMC; the policy-making branch of the Federal Reserve) last implemented a rare 75 basis point rate hike in June, with Chair Jerome Powell signaling more aggression to come on a case-by-case basis, depending on the severity of inflation. Considering that inflation in the US continues to surpass market predictions, if FOMC dispositions and Powell’s warnings hold true, USD seems primed for further bullishness.
EUR Weakness Factor #1: Acute Energy Dependence
While the EU is likewise contending with hyperinflation concerns for many of the same reasons as the US, certain underlying economic conditions exacerbating eurozone inflation are particularly worrisome. For example, much of their energy supply is contingent upon oil and gas imports from Russia, which they now have limited access to due to economic sanctions, e.g., a partial embargo on Russian oil, and open potential for retaliation.
In 2021, Russia supplied more than 25% of the EU’s crude oil imports and approximately 45% of the EU’s natural gas imports (by contrast, Russia supplied only 8% of all US imported oil). This chronic dependence enabled the European economy to endure a relatively underdeveloped energy sector, until consequences from the invasion of Ukraine strained the trade partnership with Russia. This variable makes eurozone inflation particularly devastating because of the degree to which it is caused by severely restricted supply, not merely too much consumer demand. Combined with myriad other war-related risks, this is quite bearish for EUR.
EUR Weakness Factor #2: A Timid European Central Bank
The European Central Bank (ECB), the European Union’s central bank, has been hesitant to fully commit to a pivot towards hawkishness. Although they are gradually phasing out expansionary monetary policy via 25 basis point rate hikes (which is significant considering that negative interest rates were a precedent pre-COVID), they lag far behind their foreign central bank counterparts in terms of aggression, despite 8.6% year-over-year inflation. This caution may be for a variety of reasons, including stagflation worries related to their unsettling 6.6% unemployment rate, as well as economic advantages that come with a depreciating Euro potentially boosting European exports. Regardless, the ECB is walking, not running, towards a newfound hawkishness.
Will EURUSD Parity Become the New Normal?
Regarding a long-term valuation, it is impossible to say for certain whether EURUSD parity will become a guiding principle. However, due to the aforementioned fundamentals and differing trade advantages, there is a chance that EUR’s value exceeding that of USD by the margins of the last few decades could be a thing of the past, at least for a while. Considering the extent to which the global economy has been rattled, and the disparity between the Fed and the ECB’s trajectory of monetary policy decisions, it even seems plausible that EURUSD could experience a full breakout to the downside of parity support, discovering more selling pressure.
EURUSD saw a breakout to the upside of a four month long bearish trendline on Monday, as bullish momentum caused it to close over 120 pips higher on big monetary policy news from the European Central Bank (ECB). Christine Lagarde, the ECB’s President, announced they will be pivoting away from net asset purchases, and subsequently negative interest rates, in the next several months. At the time of writing this, the EURUSD sits at 1.072 as buying pressure continues. With that in mind, let’s dive deeper as we explore how to trade EURUSD now.
As mentioned previously, EURUSD bulls have a lot to be excited about. Lagarde described the next steps in the eurozone’s monetary policy agenda as being something of a “turning point”, which is especially significant when traders consider that negative interest rates were an ECB precedent prior to Covid-era ultraloose monetary policy. This new direction, interpreted in conjunction with rising inflation in the eurozone, along with a solid 0.4% Q1 increase in seasonally adjusted GDP for the EU, are particularly validating for eager buyers.
However, when looking at the greater economic context, things may not be quite what they seem; peripheral, yet significant, data paint a bleaker picture for the EU than what the bullish momentum currently reflects. Unemployment in the eurozone is nearly double that in the US, the ECB lags far behind the Federal Reserve in terms of rate hike aggression, and the EU has gradually phased out frequent trade surpluses for deficits. On top of this, Europe is still in the throes of contending with the war in Ukraine and corresponding sanctions, with an EU embargo on Russian oil expected in the next few days. Thus, I estimate that the recent buying pressure for the EURUSD will be short lived, or perhaps only premature.
The recent breakout to the upside of bearish trendline(s) is impressive, with the historic 1.04 support level having prompted a powerful reversal for the EURUSD. However, I am anticipating a retest of the significant 1.07-1.08 resistance zone, and a return to bearish momentum. I imagine this retest will correlate with the DXY seeing a retest of its 1.02 support level, once a significant resistance level in March 2020. Thus, I entered a short position in the EURUSD at 1.07, and I am hoping to take profit at 1.04.
According to A1 Trading’s EdgeFinder tool, 31% of retail traders are currently long on EURUSD, while 69% are short, a bullish indication. This pairs well with the current COT data, which reveals about 75.5% of institutional traders going long on the USD, a decline of over 1%, while over 52% are long on the EUR, up nearly 0.5%. It is also important to note that this data, released on Friday, has not captured the bullish sentiment we have seen so far this week. However, I am still anticipating a return to form for institutional traders, wherein their orders will once again align with the general economic pessimism in the eurozone.
Learn how to trade EURUSD, the largest and most traded currency pair in the entire world. The Euro is so heavily traded due to massive economies in the United States, and European union. The need for high volumes of currency exchange between these two areas makes the EURUSD a very popular currency pair to trade. The high trading volume in this pair makes it an attractive market to trade - for both experienced and new traders. One major advantage of trading the EURUSD is that this high trading volume usually leads to tighter spreads (and hence lower trading costs + easier execution!)
When trading the EURUSD, fundamental analysis plays a large role.
A major component to the Euro rising or falling has to do with the central bank policies of each respective economy. If the dollar for example is hawkish, and has a strong outlook for the US economy, it is possible to see the Euro fall, causing the currency pair to fall.
If the Euro is strong, and/or the dollar is weak, we would expect to see weakening unemployment in the US, and/or strong figures coming from the Euro region in things like inflation (CPI), retail sales, unemployment, etc.
When trading the EURUSD, technical analysis can be a useful tool to help with entries and exits. The EURUSD shifts from being a back and forth, choppy market, to a strongly trending market.
In times of back and forth, lazy price action, the EURUSD can be a great range bound market to trade. Simple Bollinger band, and support and resistance concepts can work great when employed properly during this time.
When the EURUSD is in a trending state, watch for breakouts on the higher timeframes, and pullbacks to key levels of support or resistance.
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