Traders clearly overreact to the US inflation data

The EURUSD currency pair yesterday showed the strongest growth of 1.7%. The value of the European currency against the dollar recovered all the fall losses and returned to the levels of late August. Such a hike, most likely, was provoked by traders who massively closed short positions on the euro and long positions on the dollar. In general, yesterday's EURUSD growth momentum is justified, but its scale seems excessive. In the coming days, market participants could reassess the situation and trigger a pullback.

The reason for the collapse of the dollar was the release of statistics on inflation in the U.S. for October. The data both in monthly and annual comparison turned out to be slightly better than analysts' forecasts: the headline and core rates of price growth were less than expected by 0.1%. Undoubtedly, such figures will please the Fed officials and with high probability prevent additional increase of interest rates. However, the reaction of the currency market clearly does not correspond to the degree of normalization of price growth, and this creates risks for dollar sellers.

Despite the encouraging October data, many economists warned that inflation still “has a long way to go” before it returns to the Fed's 2% target. They also noted that consumer expectations for price increases worsened in October. Declaring a definitive victory over inflation is still premature.

Will Compernolle, a macro strategist at FHN Financial, points out the reasons for the slowdown in inflation. In October, the biggest contributors were lower energy prices (gasoline was 5% cheaper) and a slowdown in rental inflation (from 0.6% to 0.4%). However, these factors are unstable and in the next months, on the contrary, may lead to a new surge in inflation. Therefore, the demand for dollar assets could quickly return.

If EURUSD quotes fail to consolidate near the level of 1.09, the bulls will have an important reason to take profits. A correction could bring the price down to 1.08.

The following trading strategy can be suggested:

Sell EURUSD not above the level of 1.09. Take profit — 1.08. Stop loss — 1.095.

Traders can also use a Trailing stop instead of a fixed Stop loss at their discretion.