With the Federal Reserve set to push ahead with another rate hike of at least 75 basis points this week, dollar (USD) traders will be bracing themselves for another week packed with volatility. The USD has been corrective for over a week now, but the move has been showing signs of stalling. With the Fed meeting on Wednesday, this could become an important crossroads for the USD outlook.
- A 75 basis points hike is expected, but markets are gradually pricing fewer hikes in 2022 before the cuts begin in 2023.
- Reaction to US GDP could also be key
- Dollar Index correction has played out in the past week. There is more that could be seen.
Reaction to the Fed will be eyed
Reaction to the Fed meeting will be an important gauge this week. A 75bps rate hike is almost nailed on and is highly anticipated. However, the perception of how Fed chair Powell comes across could be key to pricing for future moves.
Recession concerns are mounting, exacerbated by the sharp deterioration in Friday’s flash PMI (where the Composite PMI fell into contraction at 47.5). US bond yields fell hard. When investors take a big move into US Treasuries (pulling bond yields lower) it is usually a sign of a flight to safety. The USD is a key safe-haven asset and performs well during these times.
However, at the same time, markets are changing their view of how many more hikes the Fed will fit in this year. Markets currently think that the end of 2022 will be the end of the rate hikes.
This graphic from Vanda Research shows that after Wednesday’s +75bps there may only be room for another +100bps over the rest of the year (to stop around 3.50%) before the cuts start to come in during 2023. There is a significant change from just under two weeks ago when the market was pricing for as much as another +175bps).
So, how Fed chair Powell comes across will be key. If he says that the Fed is focused mainly on inflation, at the expense of economic growth, then markets may believe that more hikes will be coming for the rest of 2022. However, if Powell begins to sound cautious then pricing for the number of Fed hikes could be further reduced.
Furthermore, we will be watching US Advance GDP on Thursday. Forecasts are looking for just +0.4% annualised growth (barely positive). Any downside surprise would likely take this negative and put the US into a technical recession. This would also drive a response from interest rates markets.
The USD has been unwinding strength over the past six days. The trigger moment was when the most hawkish members of the FOMC (the Federal Reserve’s interest rate setting committee) pulled back on talk of a 100 basis points rate hike in July.
We talked previously about the Dollar Index unwinding towards the 105.00/105.80 breakouts. This move is still possible.
However, there has been consolidation in the past few sessions which could continue into the Fed. During bull markets, the downside corrections tend to undershoot their targets. The buyers will often buy back in sooner than expected. Whilst there is more to run in this near-term USD correction, the reaction to the Fed meeting could induce the next wave of USD buying.
The question for traders will be whether bad news (fewer hikes due to recession fears) drives renewed USD buying (due to its attraction as a safe-haven).
Key levels on major pairs
Looking at major pairs, we have seen the USD correction stalling in recent sessions. This consolidation could break either way. Here are the key levels we need to watch:
EUR/USD – resistance at 1.0275 has held back the rebound. Above the resistance (continues the USD correction) and opens 1.0350. The Fed is intent on tackling inflation with more and more hikes will drive USD strength. This would pull EUR/USD lower. Below support at 1.0120 opens parity (1.0000) once more.
GBP/USD – is fluctuating under 1.2065 resistance. However, the barrier is coming under growing pressure. Above 1.2065 opens 1.2160/1.2210 and a return to the five-month downtrend. Holding a higher low at 1.1890 is key to this continued recovery.
AUD/USD – this is the pair most developed in its technical rally. It is already testing the resistance of a four-month downtrend. A close above 0.6975 would be a key sign of intent in the recovery. It would also break the downtrend. This would need a dovish Fed (fewer hikes) to confirm a breakout. If so, then it could be the first of several downtrend breaches that might come as markets continue to drive a USD correction.
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