2022-12-21 2022-12-21
Dollar: so short-sighted. Forecast as of 21.12.2022Dmitri Demidenkohttps://www.litefinance.org/blog/authors/dmitri-demidenko/
It is difficult to say precisely how financial markets will react to the BoJ’s verdict. Will investors be satisfied with the current yield growth, or will they demand more? Let’s discuss this topic and make up a trading plan for EURUSD.
Weekly US Dollar fundamental forecast
Did the Bank of Japan ruin Christmas for the financial markets? Maybe they will be encouraged by the BoJ’s decision to expand the target range of bond yields. The precedent has been created, and as a result, one of the largest central banks in the world went along with the investors. Why shouldn’t the Fed do the same? As a result, the “do not fight against the Fed” principle does not look as intimidating as it used to be. This may cause a rally in stock indices and EURUSD.
On paper, the BoJ verdict will increase the risks of capital repatriation to Japan, leading to higher bond yields worldwide. The yen and the US dollar should benefit the most from this. The greenback will strengthen due to the increase in US debt market rates and the yen due to the closing of carry positions by traders after the cost of funding increases. The popularity of playing on the difference of currency exchange rates has been actively growing recently, but the Bank of Japan ruined Christmas for its fans.
Carry trade index dynamics
Source: Bloomberg.
Although the expansion of the BoJ’s targeting range is nothing compared to the Fed’s aggressive rate hike, investors fear it will mark the end of the easy money era. Indeed, the capitalization of the negative-yielding global debt market, which once reached $18 trillion, is steadily moving toward zero. This is bad news for risky assets because funding is getting more expensive daily.
Dynamics of global negative-yielding debt index
Source: Bloomberg.
There are fears that the Bank of Japan has only provoked investors. Goldman Sachs warns that expanding the bond’s target yield range is just the first step. In 2023 BoJ will raise the overnight rate.
On the other hand, there is a law of diminishing returns in the financial markets. The central bank’s unexpected decision is shocking at the very beginning. Later, the effectiveness of its impact on the market decreases. Therefore, the current growth of treasuries and the associated strengthening of the US dollar may be temporary. The future rates on Treasury bonds will only react to the approaching recession and slowing inflation. This scenario suits EURUSD.
Goldman Sachs’ research on the Fed’s monetary restriction was based on the law of diminishing returns. It is generally accepted that the restriction affects the economy with a time lag. Bank officials agree but argue that a rate hike has its biggest impact after six months and then weakens. If so, then the current inflation slowdown may be temporary, and its acceleration in 2023 will be the basis for the Fed to increase the rate above 5.25%.
Weekly EURUSD trading plan
Thus, the future of Forex is vague. Market participants have to rely on current data. The key question is, will there be another Santa Claus rally? It is reasonable to place pending orders at the level of 1.0575 for sales and at 1.0655 for purchases.
Price chart of EURUSD in real time mode
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.
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