Previewing This Week's FOMC and NFP

This week will focus on the FOMC decision and NFP report, with the former likely to be the highlight despite expectations that rates will remain unchanged.

Fed Rate Cuts No More

Markets now expect the Fed to fully maintain its current interest rate level until at least September. Even then, there is just a 56% chance that there is going to be a reduction. This follows a divergence in key inflation indicators recently. While headline CPI began rising slightly, core PCE continued its gradual decline. The softer economic growth data also factors in, as the board aims to lower inflation without tipping the US into a recession. With forecasts showing rates remaining higher for a more extended period, recession concerns have resurfaced.

At the start of the year, markets were more optimistic that the Fed would cut rates aggressively if inflation showed a couple of months of drops. However, FOMC members were sceptical that inflation would decline at such a pace, with events since then validating that view. Although inflation has fallen somewhat, it remains above target. The job market also remains strong. Attention now turns to the likelihood of rate cuts in the year's second half and the chances the Fed goes ahead with a second cut, an outcome only 53% of market participants expect for now.

Policy to Overshadow NFP Report

In previous comments, Fed Chair Jerome Powell emphasised that higher interest rates would likely continue due to inflation pressures, with most analysts expecting a similar message at the upcoming meeting. There has been increased focus on when the Fed may begin tapering its balance sheet roll-off, with some speculating that this could start in June. Such a signal during the FOMC may be viewed as dovish.

The next NFP report, soon after the FOMC meeting, may have a more softened impact on markets just two days later. Continued strong jobs growth would simply reinforce that inflationary pressures remain high. Analysts have revised their forecasts higher. Now, they expect 238,000 new jobs compared to the prior month's 303,000. The unemployment rate is estimated to hold steady at 3.8%, but average hourly earnings are projected to exceed inflation again, rising 4.1%.

EURUSD in Wedge Pattern?

The EURUSD pair has fallen ahead of the FOMC despite stronger GDP and rising core inflation in Europe as traders price in a repeat of the Fed Chair's speech. The pair appears to have completed a short-term wedge around 1.075 and could decline towards 1.06. A break below the round support could see the euro retest a potential descending wedge trendline and could extend losses to as low as 1.055. Alternatively, a move above the upper wedge trendline could see the pair accelerate towards 1.08.

Source: SpreadEx / EURUSD

Key Takeaways

While the FOMC is likely to have a greater impact on the market this week, traders expect interest rates to remain unchanged. Attention has turned to the likelihood of rate cuts in the second half of the year and the chances of a second cut as the Fed is expected to maintain rates until at least September due to inflationary pressures. The NFP report after the FOMC may have a smaller impact as continued strong jobs growth would reinforce high inflation. Analysts have also revised forecasts higher to expect 238,000 new jobs and steady unemployment of 3.8%, with average hourly earnings projected to further exceed inflation.