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Fed's 10th consecutive rate hike spells Greenback volatility

Carl Capolingua Carl Capolingua 02/05/2023
Fed's 10th consecutive rate hike spells Greenback volatility Fed's 10th consecutive rate hike spells Greenback volatility
Fed's 10th consecutive rate hike spells Greenback volatility Carl Capolingua

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On Wednesday we'll get another instalment of from the Federal Reserve as they meet for the first time in two months to decide upon US interest rates. 

Market pricing for the official Fed Funds Rate has swung wildly since their last meeting in March. Shortly after better-than-expected March CPI data was released in mid-April, most economists were tipping the Fed would finally pause their series of rate hikes in May. Those hikes now total a whopping 475 basis points over 9 consecutive meetings. 

That data showed consumer inflation had dropped to 5% p.a. from 6% p.a. in February (and well down from a peak over 9% p.a. last year) and was followed up with significantly better than expected wholesale inflation data print which actually dipped 0.5% in March to contribute to an annual rate of 2.7%. 

At one point, many economists even began to factor in rate cuts before the end of the year as they assumed the recent banking crisis would significantly tighten credit conditions in the US economy, and therefore dampen economic growth. 

Consecutive commentaries from Chairman Jerome Powell in April poured cold water on this notion, however, as he noted not only did the Fed stand ready to deliver further hikes (not the plural), but also that cuts during 2023 were "not the Fed's base case scenario". A cavalcade of other Fed speakers confirmed a distinctly hawkish tone remained at the US central bank.

Last week, the Fed's preferred measure of inflation, the Core PCE Index logged a 4.6% p.a. gain in March, down only slightly from an upwardly revised 4.7% p.a. in February. Then we saw a worse than expected GDP Price Index (4.0% p.a., vs 3.7% p.a. expected) and hotter than expected Employment Cost Index (reading 4.7% p.a. vs 4.6% p.a. expected). Together, the data confirms the path to lower inflation in the US remains lumpy and gradual.

fed meeting FOMC interest rate probabilities
click on image to enlarge

As a result of the above factors, we head into Wednesday's meeting with market pricing for a 25-basis point hike standing at 95.4%, versus the chance of a pause at only 4.6%. Looking out to the rest of 2023, market pricing suggests this will likely be the final interest rate hike with a 64% probability of a pause in June vs a 32% probability of another 0.25% hike. There's a 66% chance of a cut of any size before the end of the year.
 

How to trade the Fed decision

However slim the chance the Fed holds fire on Wednesday, there is a chance! If this 1 in 20 probability hits, we're likely to see a sharp sell off in the US dollar against in particular, those currencies whose interest rates outlook are substantially hawkish. These are primarily the Euro and the Sterling. The EURUSD pair is going to be of particular interest this week as the ECB meets Thursday morning New York time and is expected to raise its key rate by 0.25% to 3.75%.

The near certainty of a hike this week makes the FOMC meeting itself somewhat moot. Far more important will be the post-meeting commentary by Chairman Powell. After the March meeting, his comments were considered dovish, and he eventually had to back away from them in subsequent speeches as the market swung sharply towards rate cuts in the second half of the year.

If he maintains his recent hawkish stance, and this is I believe the most likely outcome, traders should have up their sleeve a US dollar strength option. Here, longs on the USDJPY is my preferred pick based upon the charts. 

usdjpy technical analysis
click on image to enlarge

For those who prefer a more medium-term approach, daily charts are generally the best bet. They iron out much of the volatility found in the intraday periodicities and show the broader trends. Here I note the US dollar appears to be re-establishing its long-term uptrend against the Japanese Yen. My long-term trend ribbon has reverted to the dark green color, which confirms as much.

The USDJPY shows a strong short-term trend as evidenced by the rising short-term trend ribbon (light green) as well as the substantial white candles from 28 April and 1 May. These typical demand-side candles demonstrate investors are aggressively covering USDJPY shorts whilst likely also adding to strategic longs.

That price has stalled, however, as traders begin to factor in potential supply from the 8 March peak at 137.92 which coincides with the 15 December 2022 peak of 138.18. I expect a candle or two pause at this zone as supply is worked through. The timing for a break above the zone could line up very nicely with the Fed meeting later this week. 

Traders may wish to fade (i.e., with long trades) any pullbacks towards the value zone I define as my short-term trend ribbon, or possibly only as low the last peak at 135.13. Stops are naturally best set below the 26 April 133.01 point of demand. Targets are to the 21 November 2022 point of supply at 142.26 initially, but possibly to 145.10 in the medium term.


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Any opinions, news, research, analyses, prices or other information contained on this website is provided as general market commentary and does not constitute investment advice. ThinkMarkets will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.
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