With FOMC Expected to Pause, Focus Shifts to Guidance

The Fed is expected to leave rates unchanged when its policy-setting meeting ends Wednesday, with the focus on what guidance will be given for the rest of the year.

Solid Expectations

The FOMC will gather after an extended hiatus that included the Jackson Hole Symposium, where Fed Chair Jerome Powell declared that the Fed's policy would depend on data. The problem for market watchers is that the subsequent data has been ambivalent. The most recent NFP data showed strong wage growth, but the unemployment rate increased. August headline CPI rose for the second time in a row, but core inflation fell to its lowest since September 2021. This makes forecasting the trajectory of the Fed more difficult, as the data that comes out each month could change the outlook. Even the data that has come out since Jackson Hole needs to point in a clearer direction that inflation is under control, or it might start creeping up again.

However, there is a near-unanimous consensus that the Fed won't hike this time. Just 3% of traders venture to guess there will be a quarter-point hike. Therefore, the focus now shifts to what will happen after that. Nearly two-thirds of traders expect no hike in November, either. This is despite the Fed's dot-plot matrix suggesting that there is still another 25bps before reaching peak rates. Traders will be keenly focused on what Powell has to say to gauge the likelihood that the Fed will go through with that hike.

Staying the Course

It's not the first time that traders have hoped that Powell, or the FOMC in its statement, would give a sign that hiking is over. But the head of the Fed has been exceedingly cautious about announcing that the tightening cycle is over. Other central banks, such as the RBA and the BOC, have tried to pause but were forced to resume hiking as inflation bounced back. If Powell keeps to the mantra that inflation is still high and that the Fed will remain data dependent, the ambiguity around a rate hike in November will likely persist and could support the dollar.

Investors appear to be pricing in that scenario, as dollar yields have generally risen ahead of the FOMC meeting. Meanwhile, the ECB's dovish hike last week set conditions for European yields to falter as markets understand it to be the last hike of the cycle. Unlike the US, European real yields are negative. Despite the ECB hiking rates to a record high, they are still below the inflation rate. That differential has again contributed to analysts speculating that the Euro could fall back to parity unless Powell does something similar to ECB President Christine Lagarde and suggests that peak rates have been reached.

Double-Botton At Risk of Breakdown

After ending a 5-wave impulse at $1.1276, EUR/USD has been on a downward spiral that sees the $1.05 handle as a critical junction for medium-term price action. If $1.0635 ends up a double bottom and holds firm, the chances of a pullback towards $1.10 would increase in the immediate breakout past $1.0946. Bulls must reclaim the regional high of $1.0767 first. Conversely, if the drop continues and $1.05 succumbs to pressure, the next major support lies near $1.025, with an interim stop at $1.0370.

Source: SpreadEx / EURUSD

Key Takeaways

The Fed is expected to keep interest rates unchanged, with a focus on the rest of the year on guidance. Forecasting the Fed's trajectory is difficult due to ambivalent data that could change the outlook each month. There is a near-unanimous consensus that there won't be a rate hike this time, but traders will be keenly focused on what Fed Chair Jerome Powell says to gauge the likelihood of a hike later. If Powell continues emphasising high inflation and data dependence, ambiguity around a November rate hike will likely persist and could support the dollar. Investors are pricing in this scenario, as dollar yields have risen, while European yields may falter due to the dovish hike by the ECB.