Another Fed Hike is Coming; Mind the Dots

We have a very busy week ahead of us with four central bank meetings on the agenda, but the one that stands out may be the FOMC decision, scheduled for Wednesday at 18:00 GMT. Following last week’s warmer-than-expected CPIs for August, market participants put a full percentage point on the table. But will the Fed really step on the brakes harder this time, and how will the outcome affect the dollar?

How did investors achieve the 100bps bet?

At its last meeting in July, the FOMC delivered its second consecutive 75bps hike, but Fed Chairman Powell said it may be appropriate to slow the pace of future increases, painting a picture that stood far from today’s reality. The Committee did not meet in August, but investors had the opportunity to hear again from the Fed chief at the Jackson Hole economic symposium. There, Powell appeared in his hawk suit, saying they would raise interest rates as needed and keep them there “for a while.” Although he acknowledged that this could harm economic growth as well as labor market conditions, he added that these are the “unfortunate costs of reducing inflation,” and since then, many of his colleagues have agreed, with the president of the Cleveland Fed, Loretta Mester, adding that interest rates. should rise to slightly above 4%.

All this prompted market participants to add to their bets on a stronger Fed, but the icing on the cake was last week’s warmer-than-expected CPI data, which disappointed those who expected inflationary pressures to ease in the coming months and allowed to others place bets over a full percentage point increase at this meeting. According to the Fed funds futures, market participants now assign a 20% chance for such action, with the remaining 80% pointing to a 75bps increase. This may have increased the risk of disappointment and thus the chances for a failure in the dollar, even in the still very acute case of a third 75bps increase.

A new “dot plot” to determine the confidence of the dollar

However, a trend reversal in the prevailing upward trend of the dollar remains highly doubtful. Wednesday’s decision will be accompanied by updated economic projections and a new “dot plot”. Thus, the choices of investors will largely depend on this as well. Currently, market participants agree that interest rates could rise above 4%, expecting a peak around 4.4% in March, but they are against the assessment that they should stay there for some time. They are pricing in a 25bps cut by September. Therefore, a new plot showing a peak near 4.4%, but no cuts for the rest of the year – in line with recent remarks by many officials – could add fuel to the engines of the dollar and allow it to pick up any rise. related losses.

Euro / dollar could jump a little higher if the Fed rises by 75bps, but a hawkish story and a dot plot showing no rate cuts next year could allow the bears to bounce back into the action from near the lower line drawn by the high of. February 10 or near the 1.0200 zone, marked by the highs of September 12 and 13. The downward wave may result in a break below 0.9860, thus confirming a lower low and taking the pair into territories last tested in 2002. The next support could. be at 0.9615, marked by the lows of August 6 and September 17 of that year, the break of which could lead to extensions to the internal swing high of September 17, 2001, around 0.9335.

For the dollar to enter defensive mode against its European counterpart, a break above 1.0370 may be needed. Euro/dollar would already be above the mentioned downward line, while the move would confirm a higher high on the weekly chart. This may encourage the bulls to climb to the 1.0615 or even the 1.0770 barriers, marked by the highs of June 27 and 9 respectively.

Inflation expectations add to a no-cut story

The latter scenario appears to be the least likely, as another factor arguing against any rate hikes next year is that inflation expectations indicators, although recently off their highs, still point to a rate well above the Fed’s 2% one-year target . More than that, with the Fed adopting an intermediate inflation target in 2020, just hitting 2% may not be enough. Officials may choose to hook inflation there for a while, or even push it briefly below target.