The US dollar continued to strengthen against the other major currencies on Tuesday and during the Asian session on Wednesday, with most equity indices falling slightly more. All this suggests that investors remained careful ahead of the FOMC decision later in the day.
Hike bets have increased sharply after Friday’s CPI data, and they now fully price in a 75bps hike for today. The Fed was supposed to be the only major central bank meeting today, but the ECB announced an ad-hoc gathering to discuss market conditions.
What’s more, the pound was the main loser today due to reports referring to the possibility of a new Scottish Independence Referendum.
Will The Fed Deliver A 75bps Hike Today?
The US dollar traded higher against all but one of the other major currencies on Tuesday and during the Asian session Wednesday. It gained the most versus GBP, NZD, and AUD in that order, while the currency against which it failed to record any gains was EUR, with EUR/USD found virtually unchanged this morning.
The strengthening of the US dollar and the fact that the risk-linked currencies Kiwi and Aussie stayed among the main losers suggest that the financial world continued to trade in a risk-off manner due to concerns of accelerating inflation, and thereby bets over more aggressive action by the Fed.
Turning our gaze to the equity world, we see that most indices under our radar closed in the red again. The tumbles were not as severe as on Monday, but the picture suggests market participants remained cautious ahead of today’s FOMC decision announcement.
As we noted yesterday, according to the CME FedWatch tool, following the acceleration in Friday’s CPI data, investors are now fully pricing in a 75bps rate increase at this gathering, which will be the most significant hike since November 1994 if it takes flesh. They also assign a 90% probability for another triple hike to be delivered in July, while they see interest rates peaking slightly above 4% during the summer months of 2023.
In our view, the abrupt surge in hike bets has also increased the risk of disappointment. In the most recent past, Fed officials have advocated for 50bps hikes at the subsequent gatherings, and thus, if the Fed fails to deliver the expected 75bps, even a 50bps liftoff could result in a setback in the dollar.
This could also happen if they deliver a 75bps hike, but the new “dot plot” falls short of matching market expectations. Having said that, though, in either case, the Fed will likely stay among the most hawkish major central banks, and thus, we will treat such a potential setback in the US dollar as a corrective move. We would expect the dollar to regain that ground slowly.
Suppose officials deliver a triple hike, and the dot plot matches market expectations about the future. In that case, the dollar will likely continue climbing higher, despite the latest overstretched reaction against some of its major peers.
Having said all that, though, we see the case of officials matching the extremely hawkish market expectations as somewhat unlikely. We find it more reasonable for them to wait for upcoming data to arrive at safer conclusions before they signal that they will proceed so aggressively.
ECB Announces Ad-Hoc Meeting To Discuss Market Conditions
The ECB announced it will hold an ad-hoc meeting today to discuss current market conditions. In our view, they are referring to the bond market rout in Europe, predominantly peripheral bonds. At its latest meeting, the bank failed to communicate how it will deal with “fragmentation” risks when they start raising interest rates, and that’s why we saw participants selling regional bonds so aggressively.
The fact that the ECB is now stepping up to address the matter is a positive thing, and that’s why we saw the euro gaining at the time of the announcement. However, if there aren’t any important details delivered today, we see the case for the massive selling of bonds to continue.
The euro could take advantage of a potential USD weakness today when the Fed decision is made public. Still, in the bigger picture, it could come back under selling interest, with EUR/USD also driver by a possible USD recovery in the aftermath of the Fed announcement.
EUR/USD – Technical Outlook
EUR/USD traded higher today after hitting support at 1.0400 yesterday. However, in the bigger picture, the rate remains well below the downside resistance line drawn from the high of Feb. 10 and below the key resistance zone of 1.0625/50. In our view, this keeps the near-term picture negative.
Even if the rebound continues for a while, we could see the bears retaking charge from near the 1.0535 barrier, marked by the inside swing low of May 20. This could result in another slide and another test near 1.0400, the break of which could aim for the 1.0350 zone, marked by the lows of May 12th and 13th. Another break below 1.0350 could take the pair into territories last tested in 2002, with the following possible support zone at around 1.0235, marked by the inside swing high of Jul. 14, 2002.
In the bullish case, we would like to see a break above the 1.0765/88 zone, which acted as the ceiling of the range the pair traded within from May 23 until Jun. 9. This could also signal the valid break above the aforementioned downside resistance line.
The next stop may be at 1.0845, the break of which could encourage advances towards the high of Apr. 21, at 1.0935. Another break above 1.0935 could carry extensions towards the inside swing low of Apr. 1, at around 1.1025.
Pound Slumps On New Scottish Referendum Chatter
Flying to the UK, the British pound was the main loser, being abandoned after Scotland’s First Minister Nicola Sturgeon said that she was set to share details on plans for moving ahead with a new independence referendum without the consent of the British government.
According to Monday's data, this is an extra uncertainty for the UK economy, which unexpectedly shrank in April, adding to speculation that the BoE may need to move much slower than other major central banks in taming very high inflation.
Remember that the bank has warned over recession risks, which prompted investors to price in a slower rate-hike path. British officials conclude their monetary policy meeting tomorrow with expectations for another quarter-point liftoff. However, all the aforementioned information suggests that they will stay or even appear more concerned over a potential recession, which could result in further selling the pound.
EUR/GBP – Technical Outlook
EUR/GBP jumped sharply to the upside yesterday, distancing itself from the upside support line drawn from the low of Apr. 14. This also resulted in a clear break above the critical resistance zone of 0.8585, which is a trend continuation signal in our view. With all that in mind, even if we see the rate correcting its overstretched rally, we will continue aiming higher.
The bulls may take a break now that they have tested the 0.8720 zone, with a potential setback perhaps extending towards the 0.8620 barrier, marked by the high of May 12. The bulls could recharge from there and go for another test at 0.8720, which could allow extensions towards the 0.8790 zone, marked by the high of Feb. 12, 2021.
We will examine whether the bears have gained the upper hand only upon a break below 0.8480, an area that acted as a floor between May 25 and Jun. 9. This would confirm a forthcoming lower low on the daily chart and signal a valid break below the upside support line.
The next stop may be at 0.8435, the low of May 23, the break of which could carry extensions towards the 0.8393 or 0.8370 zones, defined as supports by the lows of May 3 and 18, respectively. Another break below 0.8370 could carry extensions towards the 0.8310 territories.
