Are you ready for the main event on the economic calendar this week?! 🧨
The FOMC meeting concludes tomorrow with the 2 p.m. EDT release of a new policy statement and a 2:30 p.m. EDT press conference.
Along with the policy statement, an updated “dot plot” or Summary of Economic Projections (SEP) will also be released.
Market participants are wondering if the Federal Reserve will confirm the bond market’s aggressive rate cut expectations or provide a hawkish surprise.
Recently, the bond market has priced in a lower terminal fed funds rate (“peak” rate) and several rate cuts by year-end.
The FOMC’s decision will likely impact the U.S. dollar, crypto, stocks, and bonds, potentially causing renewed market volatility.
Let’s take a look at what the financial market will be focused on, along with the different scenarios of what the Fed might do and the likely market reactions to each.
🔑 Key Issues to Consider:
Here are the key issues that market participants will pay attention to in the new policy statement, SEP, and during the press conference by Fed Chair Jerome Powell (“JPow”):
- Terminal fed funds rate expectations
- Year-end fed funds rate
- Inflation and labor market conditions
- Banking crisis and financial contagion risks
👀 Expected Scenario: 25 bps Rate Hike and No Change to the Dots
Likely market reaction:
- Moderate rally in the U.S. dollar
- Moderate drop in stock prices, led by growth and cyclical sectors
- Treasury yields rise, with the 2-year yield rising more than the 10-year
🕊️ Dovish Scenario: No Rate Hike or 25 bps Hike with Clear Pause Signal
Likely market reaction:
- The U.S. dollar drops sharply
- Commodities, especially gold, benefit from dollar weakness
- Stocks rally, led by growth and tech sectors
- Treasury yields drop, with 2-year yields falling faster
- Degens return and pump crypto to the moon!
🦅 Hawkish Scenario: 25 bps Hike and Terminal Fed Funds Above 5.125%
Likely market reaction:
- Significant rally in the U.S. dollar, negatively affecting gold and commodities
- Commodities fall due to dollar strength
- A sharp decline in the U.S. stock indices
- Mixed Treasury yields, with 2-year yields, spiking and 10-year yields declining
- Bitcoin and ether plummet
🤔 Bottom Line: A Challenging Rate Decision
The FOMC meeting presents a difficult decision for the Federal Reserve.
Fed officials have two main options when deciding how to fight inflation while also dealing with bank failures.
- They can either ignore it and keep focusing on keeping prices stable by continuing to raise interest rates, even though that could cause even more stress in the banking sector.
- Or, they can do nothing for now to give the financial system time to settle down, even if that means price pressures will stay high.
They must balance the risks of inflation, economic damage from the banking crisis, and market expectations.
A dovish Fed risks not being able to bring inflation lower. On the other hand, the Fed doesn’t want to make the mistake of hiking rates and causing contagion across financial markets.Given these risks, the most likely outcome is a 25-bps hike with no change to the dots.
However, the Fed may alter its approach if necessary based on unfolding events, and they will clearly express that contagion could change the course of action.
In terms of price action for USD, it’s clearly down from its highs and has been trending downward. While it regained some strength near the start of February, breaking its market structure of lower highs and lower lows (by creating a higher high), the price failed to retest the 200 SMA (blue line) and buying pressure has weakened lately.
Currently, it’s trading below its 200 SMA (blue) and holding above its 50 SMA (pink).
Keep an eye on the 50 SMA and watch how the price reacts around this moving average tomorrow. If/when the price tests this moving average for support, dollar bulls will want to see any downward pressure quickly rejected.
If not, beware of further dollar weakening….which is what JPow may prefer.
To help ease global financial conditions, JPow will want to keep a lid on any dollar spikes.