Sat, Mar 25, 2023 @ 04:54 GMT
HomeContributorsFundamental AnalysisFed Widely Expected To Hike Rates, Forward Guidance To Move The Dollar

Fed Widely Expected To Hike Rates, Forward Guidance To Move The Dollar

The Federal Reserve will be completing its two-day meeting on monetary policy on Wednesday, with an interest rate decision being made public at 1800 GMT. The world’s most powerful central bank is widely anticipated to deliver a quarter percentage point interest rate hike, with market focus falling on the Bank’s forward guidance. Moreover, this will be the first meeting that new Fed chief Jerome Powell will preside, something which perhaps renders his press conference following the decision all the more interesting, with market moving comments by Powell not to be ruled out.

The US central bank is expected to increase the Fed funds rate by 25 bps for the target rate to enter a band between 1.50-1.75%. Interest rate futures have fully priced in the move, with FOMC policymakers highly unlikely to take markets by surprise by deviating from this expectation.

Given that an interest rate increase is pretty much seen as a done deal, all eyes will be on the Fed’s forward guidance, perhaps most notably its dot plot which will reveal how FOMC members see interest rates evolving moving forward. The plot’s previous release showed policymaker consensus for three quarter percentage point increases in 2018. Currently there’s speculation in the markets that the FOMC will move towards four, including the one that is to be delivered on Wednesday that is. Is this justified though?

Some arguments against such signaling are the following: if the data throughout the rest of the year do not support a fourth hike and the Fed eventually ends up scaling back its expectations – that is in case Wednesday’s dot plot indeed signals four 25 bps rate hikes in 2018 – the unintended market reaction is likely to be much more profound than if the Fed sticks to its current guidance and proceeds accordingly depending on economic releases. In other words, there seems to be much more to lose if the Fed signals four hikes and then reverts to three, than if it sticks to three and eventually ends up delivering four. Also, signaling four hikes and eventually delivering three will lend credence to those saying that the Fed tends to overpromise and in the end underdelivers. Such an outcome will constitute somewhat of a blow to the central bank’s credibility, something which the new Fed chief will likely try to avoid.

Still it is worthy of mention that several investment banks, including Goldman Sachs, expect the median projection to rise to four hikes in total for 2018 on Wednesday. Markets though have at the moment far from priced in a fourth interest rate increase during 2018 according to the CME Group’s FedWatch Tool.

Elsewhere, the wording in the FOMC statement has its significance as well and can spur positioning on the dollar, as it is expected to reveal whether policymakers are worried about the recent misses in data such as retail sales which have led to downward revisions in Q1 GDP projections. Assuming the confidence Powell expressed in his testimony before Congress around three weeks ago is echoed by the majority of FOMC members – this was the catalyst behind the markets upgrading their projections in terms of Fed tightening and thus fully pricing in three interest rate hikes in 2018 – then the statement should also sound optimistic. Still, any concerns on the outlook for growth can exert downward pressure on the greenback; the opposite holds true as well.

Also of importance is Powell’s press conference which is set to take place at 1830 GMT. His recent comments before Congress were dollar-positive. It remains to be seen whether he will provide another lift to the US currency on Wednesday. Overall it is highly likely that the dollar will be volatile around the time of the announcement and press conference as Fed meetings with press conferences, revised forecasts and a new dot plot occur only once a quarter and as such, are closely scrutinized by market participants searching for insights into the Fed’s policy intentions.

Upbeat views by Powell and Fed policymakers on the state of the US economy, in conjunction with a reiteration of the Bank’s commitment to firmly remain on a path of policy normalization, are likely to lend some support to the dollar. Focusing on euro/dollar, the pair seems to be currently meeting a barrier to downside movements around the 50-day moving average line at 1.2316. A downside violation would turn the focus to the area around the 1.22 handle which was somewhat congested recently and also encapsulates a bottom from the recent past at 1.2204. Further below, additional support could come around 1.2153, this being a two-month low that was recorded on March 1.

Potential concerns about the economy or a mention of the lack of progress in the core PCE index – the Fed’s preferred measure of inflation – on the other hand, could weaken the greenback. Resistance to upside moves in euro/dollar might come around the 1.24 level which, since late January, was often congested. Further above, the one-month high of 1.2446 from March 8 would be eyed before market attention starts to increasingly shift towards February 16’s three-year high of 1.2555.

Finally, and moving back to the “fourth hike debate”, it is interesting that despite prospects of more Fed rate increases being theoretically dollar-supportive, at the moment there are other currency drivers at play that might act to the detriment of the dollar should such signaling take place, and forex market participants seem to be increasingly wary of these factors. For example, hawkish guidance could trigger a sustained selloff in US equity markets, which might be bearish for the dollar and the US economy and boost other currencies such as the safe-haven perceived yen. Reaction of certain dollar pairs in this case might deviate from what “conventional wisdom” dictates.
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