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Fed in a race against time to raise rates

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As the next FOMC meeting looms, markets are wondering whether the Fed can keep tightening even as the economy begins to stagnate.

FedSource: Bloomberg
 Chris Beauchamp | Chief Market Analyst, London | Publication date: Monday 02 May 2022 

What to expect from the FOMC meeting

The upcoming Federal Reserve (Fed) meeting in May is expected to see a 50-basis point (bp) hike, the biggest in over two decades.

What else might the Fed say?

The 50-point move has become the market’s basic expectation in recent weeks, since chairman Jerome Powell said that such a move would be appropriate. However, as with all meetings of central banks the real market-moving event is likely to be any suggestion that some policymakers will be calling for an even faster pace of rate hikes.

This would likely put further upward pressure on the dollar, which has already moved to a near-20-year high as the Fed looks to battle rising inflation.

Strong US economy helps the Fed’s plans

For now the US economy is still in reasonably strong form, although the 1.4% contraction in first quarter (Q1) GDP according to the first estimate of data will raise worries that a recession could be on the cards soon. Consumer spending has yet to turn solidly lower however, although real pay continues to fall, raising the prospect of a crimping of consumer outlays in the near future.

But inflation continues to rise strongly. March’s price increase was 8.5% year-on-year (YoY), and so the Fed still has work to do. Ideally, the central bank would like to get rates back towards 3%, in order to give them some reasonable firepower when the next economic downturn hits and rates need to be cut to support the economy.

As we move into the middle of 2022, the Fed has a tough balancing act to perform, as it looks to get control over inflation without tipping the economy into recession.

US dollar outlook

The past month has seen the biggest surge in the US dollar since 2014. The dollar basket has rallied back to highs last seen in 2016 and 2020, building on the gains seen since the 90 level back in the middle of 2021.

A break higher now looks to be on the cards, unless the Fed provides a more cautious outlook in the short term, or perhaps if the Federal Open Market Committee (FOMC) does not see further calls for a faster pace of tightening. Given the scale of the gains in April, the price does look overextended, and a drop below 100 would mark a short-term top.

US dollar chartSource: ProRealTime
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