The Federal Reserve has clearly won the fight against inflation. Victory is not inevitable, and its timing is not determined, but no one is talking about stagflation or hyperinflation at the moment. The markets responded favorably to the June consumer price index, fueling the dollar sell-off. EUR/USD surged to 15-month highs, and this is far from the limit. Economists at Deutsche Bank expect EUR/USD to rise to 1.15 by Q4 2023, while Eurizon SLJ Capital suggests the 1.2 level.
When the divergence in monetary policy between the European Central Bank and the Federal Reserve is accompanied by heightened global risk appetite and the decline of American exceptionalism, the US dollar is forced to raise the white flag. Currently, the gap between consumer and producer prices is at a record high. When such situations have occurred in the past, stock markets have risen. This has happened either in the very late stages of a recession or in the early stages of an upturn.
Dynamics of final demand and finished goods prices in the US
It is quite possible that the United States will be able to avoid the recession that has been talked about for so long. The markets are envisioning a Goldilocks scenario—a combination of slowing inflation and steady GDP growth just below trend. It's no wonder that the S&P 500 reached a 15-month peak. It is difficult for the US dollar, as a safe-haven asset, to withstand such a significant improvement in global risk appetite.
The Fed's aggressive policies will eventually start to slow down the economy. Meanwhile, China is likely to accelerate the recovery of its GDP, which will have a favorable impact on the export-oriented eurozone. As a result, the bullish factor of American exceptionalism for the US dollar will become a thing of the past.
The hawkish comments from FOMC officials don't help the EUR/USD bears either. Christopher Waller still expects a federal funds rate hike to 5.75% and claims that making decisions based on a single inflation report is reckless. We can't sit and wait for the economy to cool down. It's like waiting on the platform for a train that has already left.
At the same time, the euro is supported by the minutes of the June ECB meeting and a speech by Isabel Schnabel. The ECB official said that despite the slowdown in inflation, markets are sending different signals. They reflect investors' concerns about whether the central bank has done enough to tackle high prices. In the latest Governing Council meeting, one official voted for an immediate 50 bps rate hike.
It seems that the ECB is not planning to stop, while the Fed may force a significant inflation slowdown. Along with heightened global risk appetite and the loss of American exceptionalism, this allows us to expect that the euro will continue to rally against the US dollar.
Technically, on the EUR/USD daily chart, reaching targets at 127.2% and 224% based on the AB=CD pattern increases the risk of a pullback. For this to happen, the pair would need to drop below the pivot level of 1.1215. Any decline should be used to form long positions.
