The dollar is walking on thin ice

[Ben Graham]

Does the US president get what he wants as if by divine will? Alas, anyone versed in economic theory understands that Donald Trump's ideas are insane. Cutting the federal funds rate to 1% in the face of inflation exceeding the 2% target would make consumer price growth uncontrollable. At the same time, the dollar would weaken. That is likely what the White House owner wants, to boost the competitiveness of US producers. The problem is that the decline of the USD index will not be gradual. It will resemble a fall off a cliff.

The US dollar is the main reserve currency. It accounts for about 60% of central banks' foreign exchange reserves. Each of them wants to be confident that mistaken White House policy will not lead to uncontrolled inflation and the devaluation of their assets. If such doubts arise, American assets will be sold off, triggering a collapse in the USD index. A characteristic example is the bond market's reaction to escalations in conflicts between the executive branch and the Federal Reserve. Yields on treasuries rose at such moments, indicating they were being dumped.

Dynamics of US Treasury yields

If Donald Trump manages to implement his crazy plans, the US dollar will not escape a crash. But so far, markets consider such a scenario unlikely, which puts pressure on EUR/USD.

According to Credit Agricole, the idea of divergence in monetary policy between the Fed and the European Central Bank will not be realized. The Fed will keep the federal funds rate at 3.75% through the end of the year, and the wide spread with the ECB's deposit rate will exert downward pressure on the euro. The strength of the US economy and the theme of artificial intelligence will continue to attract money from the EU to the US equity market. At the same time, high borrowing costs will make hedging expensive and reduce its scale. The dollar will benefit.

Credit Agricole calls geopolitical risks a headwind for EUR/USD. Especially because of potential conflicts between the US and NATO over Greenland, between the US and China over Iran, Venezuela, and Japan. A failure of diplomacy over Ukraine would prolong the armed conflict, further slowing the eurozone economy. Finally, political risks in Europe can resurface at any time. France will continue to exert pressure on the euro.

Thus, if Trump's plans for fiscal dominance are not realized, the main currency pair is more likely to continue its southward march than to return to a resumed uptrend.

Technically, on the daily chart, EUR/USD is forming an inside bar. Traders can place pending buy orders for the euro at $1.1675 and sell orders at $1.1650.

The material has been provided by InstaForex Company - www.instaforex.com