FOMC Focus Shifts Beyond Next Meeting Already

There is strong agreement that the Fed will hike tomorrow despite First Republic Bank's recent turmoil. However, doubts about what comes after continue to grow.

Almost A Done Deal

Over four-fifths of traders expect the Fed to hike by 25bps, leaving the rate at 5.00-5.25%. This would be in line with comments from Fed officials in the lead-up to the blackout period and following last month's meeting that suggested at least one more rate hike. The turmoil in the banking system is seen as raising borrowing costs, having an equivalent impact on the market as if the Fed were tightening. The expectation is that the FOMC will vote for a rate hike to preserve the Fed's inflation-fighting credibility, as its preferred measure of inflation, PCE, was still twice the target rate at 4.2%, although down from 5.1% in February.

Dissenters argue that inflation has fallen precipitously over the last month, which the Fed could point to as policy working. Traditional economic theory suggests a long time between when monetary policy is enacted and when the effects are seen. That could give a reason for the Fed to pause to avoid overtightening as inflation is coming down and, simultaneously, provide some relief to the banking system.

Going Beyond Next Meeting

The expectation is that traders will be focused on what Fed Chair Jerome Powell communicates in his post-rate decision presser about what's coming next. At the moment, the majority is in favour of a rate hike at this meeting and announcing a pause at the next one (scheduled for June). That's where views diverge too. The Fed insists it will keep rates higher, but markets expect at least two rate cuts starting in September.

If the FOMC statement drops references to & further rate hikes, the market will likely interpret it as the Fed saying this is as high as rates will go this year. But further hawkishness, such as suggesting that more rates might be in store, has not managed to convince the market in the past, with the initial market reaction fading rather quickly. Comments from Powell that imply rates could come down at some point this year would be a major shock to the system but are considered extremely unlikely.

EUR/USD Handle Turns Triangular

Euro bulls failed to reach $1.11, and prices against the dollar slid under $1.10 just recently. The decline brings the cup-and-handle pattern into question; however, if the handle completes a running triangle anywhere above $1.0909, the situation might remain unchanged.

Continuing into overlapping price action might eventually lead to a breakout toward $1.1165. This is where the measured-move projection lies, coinciding with the 38.2% inverse Fibonacci of the $1.0909-$1.1095 leg (assuming a symmetrical triangle, which typically ends by 50%). Losing the floor, however, might enact further declines toward $1.0800, elongating the handle's depth or entirely invalidating it.

Source: SpreadEX / EURUSD

Key Takeaways

The Fed is expected to hike by 25 bps, leaving the rate at 5.00-5.25%, with traders focused on what comes next after the meeting. Some expect a rate hike and a pause at the next meeting in June, while others anticipate at least two rate cuts starting in September. Comments from Fed Chair Jerome Powell that imply a rate cut this year would be highly unlikely but could cause a shock to the system. The decline in EUR/USD brings the cup-and-handle pattern into question, but a running triangle completing above $1.0909 might lead to a breakout toward $1.1165.