Will the Fed surprise the markets?
EUR/USD slipped to support at 1.1080 due to several reasons:
- profit taking on EUR longs;
- positive expectations from the Federal Reserve’s meeting;
- emerging market currencies’ weakness caused by lower commodity prices;
- better global risk sentiment.
Bears will likely keep the pair under pressure on rumors of potential Federal funds rate hike already in May. The majority of the 53 experts surveyed by Financial Times expect a rate hike only in June, but a surprise is possible. CME futures show that the market is pricing in more than 50% possibility of a hike in June versus 18.5% earlier.
The forecasts for the Fed’s rate hike
Source: Financial Times
The main risk for the US dollar ahead of the Fed’s meeting is that the central bank will cut rate forecasts. The last forecast made in December of the 1.375% rate implied 4 rates hikes this year starting in March. If the forecast is reduced to 0.75-1%, it will be dovish and negative for USD, whereas a reading of 1.25-1.375% will make traders buy American currency.
The thing is that if investors will be expecting the Fed to raise rates, they will buy USD making it strengthen. This, in turn, will prevent the Fed from raising rates. As a result, it would be wise for the Fed to increase rate now, when the greenback’s value is low.
The situation at global financial market has stabilized. Chinese yuan rose, the unemployment rate (4.9%) is close to the Fed’s forecast for the end of 2016 (4.7%), Dallas Fed inflation index was at 1.9% in February, core PCE index rose by 1.7%. All of these speaks in favor of the Fed’s rate hike. Strong economy should have stronger currency, and that’s why USD will strengthen.