Fed Decision: What you need to know

July 27, 2022

When is it due?

The FOMC policy statement is due at 6:00PM GMT
Fed Chair Jerome Powell is set to hold his press conference at 6:30PM GMT.

Here are the key points to look out for:

The Fed is widely expected to raise its benchmark interest rates by another 75 basis points.
Anything else would be a surprise.A 75-basis point hike is 3 times larger than the customary 25-basis point adjustments that central bankers traditional deploy per meeting. Given the roaring inflation figures around the world, central bankers have been deploying such larger-than-usual hikes in a bid to stop consumer prices from rising uncontrollably.
Note: Interest rate hikes are a central bank’s main weapon in trying to subdue runaway inflation.
The Fed has already raised interest rates by a total of 150 basis points since March (excluding today’s forecasted 75bps hike):

March: 25bps hike
May: 50bps hike
June: 75bps hikeAs you can see, each hike has gotten incrementally bigger.
Hence, faced with multi-decade high inflation, the Fed is roundly expected to fire yet another 3-in-1 shot today. Back-to-back hikes of 75bps at a time are the most aggressive seen out of the US central bank since the 1980s.
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It figures, given that inflation is also at its highest since the early 1980s.
Recall that, back on July 13th, we learned that the US consumer price index a.k.a. CPI (which is used to measure how much consumer prices have changed) rose by 9.1%.
Not only did it beat market forecasts, but that was also the fastest CPI year-on-year growth since November 1981.

After today’s decision, markets are expecting an additional 100bps in hikes over the Fed’s remaining three policy meetings scheduled for the rest of the year.Given the forward-looking nature of the markets, investors and traders are already trying to anticipate how high US interest rates will go before the curtains come down on 2022.
Adding today’s 75bps hike with the additional incoming 100bps by year-end, that would raise the upper bound of Fed Funds target rate up to around 3.5%.

If today’s policy decision and press conference play out exactly as per the above-listed scenarios, then it could be a ho-hum session for FX markets.

However, if there’s any clue that forces markets to significantly alter those above-listed expectations, then we could see heightened volatility across FX markets (and also stocks, commodities, and even crypto; across asset classes).

How would this impact the US dollar?

If the Fed triggers a smaller-than-expected 50bps hike, that could result in a softer US dollar.
If the Fed triggers a larger 100bps hike, that could jolt the US dollar back to recent heights.
Up until a couple of weeks ago, some market participants had forecasted a 60% chance that the Fed could trigger such a gargantuan move, in light of the fresh multi-decade high in the headline CPI print (as mentioned above). Those odds (for a 100bps hike today) now stand at just 14%, at the time of writing.
If Chair Powell suggests that the Fed will have to incur more hikes through year-end, more than the 100bps that’s been priced in by the markets for the September-December meetings, that should also lift the US dollar.
If Chair Powell suggests that the Fed will have to slow down its intended rate hikes, for fear of sending the US economy into a recession, that could see the US dollar moderate further.

Expect a combination of the above-listed scenarios.

How do market forecasts surrounding rate hikes affect FX pairs?

Generally, the more aggressive a central bank is about raising its own rate, the stronger its currency, relative to the other currency whose central bank is deemed to be lagging behind.

For example:

The Fed has already raised its rates by 150 basis points since March.After today’s 75bps hike (if it happens), markets expect another 100bps to go through the end of 2022.
If so, that would bring 2022’s total of Fed rate hikes to 325 basis points.
In contrast, the European Central Bank (ECB) has only hiked once so far this year, by 50 basis points just last week.Markets are expecting another 110 bps in hikes through the end of 2022.
That would bring 2022’s total of ECB rate hikes to 160 basis points

With the Fed clearly being more aggressive with its rates hikes compared to the ECB (325bps vs. 160bps in total hikes expected for 2022) this has resulted in declines EURUSD.

No surprise that the world’s most popularly-traded currency pair has remained around 20-year lows close to parity in recent weeks.

US dollar set to remain sensitive to shifting expectations surrounding incoming Fed rate hikes

In order to assess how the US dollar might react overall in relation to its G10 peers, one could just look at the equally-weighted USD index (as opposed to the benchmark dollar index – DXY), which measures the buck’s performance against six other major currencies all in equal proportions:

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

Key support and resistance levels for USD Index

Resistance: 1.195 area (the mid-May and mid-June cycle highs)
Stronger resistance set to arrive above 1.21, around the mid-June peak
Support: 1.18 (the upward trendline since April)
Stronger support set to arrive at the 50-day simple moving average (SMA) around 1.175

Generally, as long as the Fed can persist with its pedal-to-the-metal approach in raising US interest rates, assuming the US economy can withstand such elevated rates, that should ensure that the US dollar remains well supported.

Article by ForexTime