Key Talking Points:
The Federal Reserve is due to conclude its two-day meeting today and money markets are pricing in tighter measures to tame overheating inflation. Whilst expectations for rate hikes have been brought forward, the likelihood of a rate hike today is pretty much completely off the table, so the focus will be on the tapering of asset purchases. These expectations have pushed yields higher, especially on shorter-dated bonds, flattening out the yield curve, as there is perceived to be less need to brace for inflation longer into the future.
The fact that the Fed will start scaling back its $120 billion-a-month asset purchases is pretty much a given, with the reduction likely to be on autopilot from here on out. But there are still risks for the Fed in this meeting as they will be setting out the path of its monetary policy in the post-pandemic recovery era. How they communicate their intentions is going to be key. If they seem too aggressive, investors could get nervous about impending rate hikes, but if they show continued dismissal investors could pile into the bond market again looking for protection from untamed inflation.
As of now, the first rate hike priced into markets is in June 2022, but that will likely change as time passes. It’s common for expectations to shift as new information comes in, but the Fed is going to have to be careful with its wording if it wants to avoid an overly-active bond market, especially when choosing the wording around the notion of “transitory” inflation, which could now include keywords such as “partly”.
Positioning in the Dollar is back near yearly highs after posting a strong session on the back of Friday’s month-end rebalancing and a strong inflation reading. The bearish case would be a lack of hawkishness from the Fed, with an announcement of expected tapering but failure to acknowledge elevated inflation in order to avoid upsetting the bond market. Abandoning its dovish stance and giving into the less transitory nature of inflationary pressures is likely to give the Dollar an extra boost.
USD/JPY: the pair continues to hover around its 4-year high (114.705) ahead of the Fed meeting playing into its appeal as rate differential trade. A stronger Dollar on the back of the Fed meeting will also play into the widening yield gap as the BoJ vows to keep an ultra-lose policy whilst other banks, like the Fed, continue to run ahead. The pair seems to be facing resistance around current levels and I would expect that to continue in some way, but it won’t be long before USD/JPY is attempting to break above strong resistance at 114.77, which has likely been weakened after several attempts to break higher in the last 4 years. A weaker Dollar will likely see a retracement towards 113.25 but bears will struggle to gain the upper hand, with strong support at 112.00, where the 50-day SMA is converging.
USD/JPY Weekly Chart
USD/CAD: the pair may be facing another leg lower if the Dollar fails to strengthen its momentum after the Fed meeting as it has been facing challenging resistance in recent weeks. Recent trade has mostly been sideways, with 1.2432 as a short-term top, but there has been a slight tilt higher in the last few sessions, meaning bullish momentum could pick up quickly if the Fed fuels another USD rally. IF so, 1.2496 (127.2% Fibonacci retracement) is likely still going to offer some resistance. On the flip side, a move lower may see bears targeting a break below support at 1.2290.
USD/CAD Daily Chart
EUR/USD: despite attempts to rebound, EUR/USD has continued to trade in a downward pattern since the highs seen in May. The outlook still isn’t very good for the pair, as the Euro may continue to be overpowered by the Dollar, with the pair having found renewed selling pressure between 1.1613 and 1.1700 at every attempt at a bullish reversal in October. The next point of reference comes in at 1.1500, which puts the pair at risk of a further pullback towards 1.1370.
EUR/USD Daily Chart
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— Written by Daniela Sabin Hathorn, Market Analyst
Follow Daniela on Twitter @HathornSabin
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