Week Ahead: Lower dollar if Fed surprises with “smaller” 50bps hike

July 22, 2022

Are you ready for yet another jumbo-sized Fed rate hike?

Markets have been preparing for such an outcome at the upcoming FOMC policy decision, which will star in next week’s economic calendar

Monday, July 25

EUR: Germany July IFO business climate
GBP: UK PM candidates’ debate – Rishi Sunak vs. Liz Truss

Tuesday, July 26

JPY: Bank of Japan June meeting minutes
USD: US July consumer confidence
IMF releases updated world economic outlook
Alphabet 2Q earnings

Wednesday, July 27

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AUD: Australia Q2 CPI
CNH: China June industrial profits
USD: Fed rate decision
US crude: EIA weekly oil inventory report
Meta Platforms 2Q earnings

Thursday, July 28

AUD: Australia June retail sales
EUR: Germany July CPI, Eurozone July economic and consumer confidence
USD: US Q2 GDP, weekly jobless claims
Amazon 2Q earnings
Apple 2Q earnings

Friday, July 29

JPY: Japan June unemployment, retail sales, industrial production; July Tokyo CPI
EUR: Eurozone July CPI, Q2 GDP
USD: US June personal income and spending, PCE core deflator, July consumer sentiment
Exxon 2Q earnings
Chevron 2Q earnings

Markets have fully priced in a second consecutive 75-basis point hike at next week’s FOMC policy meeting, as the US central bank continues its battle against the hottest inflation in 40 years.

However, that 75bps hike is a relative step down from the 100-basis point hike that some segments of the markets were expecting. Hence the recent unwinding of gains in the equally-weighted USD index. Still, this instrument is well within its uptrend since Q1 2022.

Note that this index compares the US dollar’s performance against six of its major peers, all in equal weights:

Euro
British Pound
Swiss Franc
Australian Dollar
New Zealand Dollar
Canadian Dollar

Any other outcome that deviates from the 75bps script would be a surprise.

DOVISH: A “mere” 50bps hike, though still twice the size of the traditional 25bps rate adjustments per meeting deployed by central bankers worldwide, should prompt more declines in the USD index, potentially moving it closer to its 50-day simple moving average (SMA) around the 1.175 region.
HAWKISH: Although the bar has been set high for a hawkish outcome at next week’s meeting, a 100bps shocker would reinvigorate dollar bulls into sending this USD index back above the 1.20 line. More dollar gains may also ensue if Fed Chair Jerome Powell, during his press conference, refuses to rule out a 100bps hike at upcoming meetings.

Ultimately, policymakers at the US central bank, as well as market participants, will continue to be guided by the inflation data.

And on that point, after the FOMC meeting concludes, next Friday’s release of the June PCE deflator will be closely watched, considering that it’s the Fed’s preferred way of measuring inflation.

The PCE deflator is forecasted to come in at 6.6% in June, which would mean that it has posted a reading of 6% or higher for every month so far this year. 6.6% is also more than three times the Fed’s 2% target, underscoring the tremendous task that the Fed is up against.

Further evidence of stubbornly elevated price pressures is set to force the Fed into triggering even more jumbo-sized rate hikes over the coming months. Such hawkish expectations could then see the USD index being restored to the last cycle high at 1.21859, or perhaps even higher.

Overall, as long as the Fed keeps the “pedal to the metal” while leaving other major central banks struggling to catch up with their own rate hikes, that should leave the buck with an easier path to climb even higher.

Article by ForexTime