Wall Street is higher and the dollar has found its feet again as traders turn their attention toward the Federal Reserve two-day monetary policy meeting, which concludes on Wednesday. Following the meeting the market will be updated with a rate announcement and a press conference, the first by new Fed Chair Jerome Powell as he replaces former Chair Janet Yellen.
The market is widely expecting a rate hike to be announced at 18:00 GMT on Wednesday, with 25 basis point increase in the interest rate being considered as good as a done deal. The CME Fed Watch is pricing in a 94% probability of a March rate hike, so once confirmed trader’s attention will quickly push past the headline to what the Fed is expecting to do across the rest of the year.
Currently traders are divided as to whether the Fed will stick to the previously plotted 3 rate rises across 2018, or whether Fed officials under Jerome Powell will put a hawkish stamp down early, shifting away from Yellen’s more dovish tone to a more aggressive pace of tightening across the year.
More Tailwinds Than Headwinds
The economy is in a sweet spot right now, inflation is gradually moving in the right direction toward the Fed’s 2% target, the number of jobs being created is exceptional, a boost from the tax cuts will be feeding its way into the system, strong global growth, a weak dollar, the list goes on. As Bainard recently pointed out, the US economy faces more tailwinds than headwinds, giving the hawks at the Fed have plenty of reasons to be getting nervous that the economy could quickly start overheating.
On the other hand, although inflation is moving toward the 2% target, there is still some slack in the labor market to be picked up and retail sales remain subdued suggesting that inflation may not gather pace as quickly as the Fed initially hopes.
Either way, there are still plenty of reasons for the Fed to stick to the current path of gradualism. The Fed is not about to inform the markets of a heavy-duty policy change; however, they have been and are making it clear that the path of rate hikes is more likely to rise than fall. This is a message we expect the Fed to continue with, even if the dot plot isn’t adjusted higher toward a faster pace of hiking tomorrow.
Potential Market Reaction
Treasury yields have already been climbing across the day in anticipation of tomorrow’s meeting, The US 10-year yield jumped to 2.87, its highest level in over a week, although still considerably lower than the 2.94 peak reached one month ago on fears that the Fed was behind the curve. Higher yields have boosted the appeal of the dollar, which is trading 0.6% higher versus a basket of currencies, through the psychological level of 90.00 at 90.25.
We expect some volatility this afternoon as traders reposition themselves, ahead of a cautious morning of trading prior to the release. Any upward shift in the dot plot, indicating a faster pace of hiking could boost the dollar, as could general posititvity from Powell, let’s not forget that his last appearance before Congress was a dollar positive event. In these scenarios we would expect to see USD/JPY move towards resistance at 106.70, before targeting 107.
On the downside any mention of concerns over the rate of inflation could worry dollar traders, sending USD/JPY down toward support seen at 106.30. Beyond this the bears will target 106, before looking towards 105.50.