Fed preview: what could the Fed say to move the markets?

[MongiIG]

Central bank transparency means few surprises to move markets when the Fed rate decision is announced. Does it still have a surprise to shift the dollar? We look at the potential for upside and downside moves in forex markets.

 

 Jeremy Naylor | Writer, London | Publication date: Wednesday 01 February 2023

Fed rate decision

It is the US interest rate decision tonight at 7pm UK time. While there’s little move in the currency markets so far this morning ahead of the announcement, it is an event that could well move the markets when we see that detail coming through from the Federal Reserve (Fed) and also at the press conference a little bit later on.

The expectation

Let's take a look at the detail as we're expecting it to break this evening. It's expected to raise interest rates by a margin of 25 basis points, a quarter of one percentage point, to a range of between four and a half and four and three quarter percent. But the big question is how long will the Fed remain on this tightening path?

Now, this 25 basis points expected follows a 50 basis point increase in December and four successive 75 basis point interest rate rises previously.

Dollar basket

Let's look at what's happening with the dollar basket. As I said, not much move at the moment at 10173. Now this direction of travel here showing the dollar weakening away from the highs that we saw back in September last year when the Fed was in that aggressive tightening cycle.

Since then, we have seen lots of evidence to suggest that the Fed is wanting to take its foot off the pedal a little bit - 25 basis points is already priced into these markets as things stand there at the moment.

There's a little bit of an uptick in the momentum, indicating that there is an appetite, I think, to take this market higher. But if the Fed comes through with anything like the sort of dovish reports in the press conference that some are expecting, we could well see some of that unwound.

EUR/USD - trading the move

So how do you trade this? Well, let's take a look at the opportunities here. Let's assume that the Fed is going to be dovish, maybe more so than had been the case previously. The euro/dollar trade would go higher and at 10873, you'd put your stop below this area down here at around about the 10750 level, 10873.

The area to beat is this 10936, which is the highs that we saw back on the 21st of April last year. Now that's long euro/dollar. Assuming we get a dovish Fed, if the Fed looks like it wants to keep its foot on the pedal, if it wants to continue to try and combat inflation, which is certainly the mantra that we're getting and we have in the past, that's what central banks are meant to be doing. In that case, you would go short on this, and I think there's more money going into the dollar.

If we see something more hawkish from the Fed, in which case you go short on this with a stop above this area up here to round about the 10970 level, with a view to taking this lower depending on what the outcome is of that interest rate decision.

GBP/USD

And the Fed statement tonight, I just want to show you what's happening in sterling against the US dollar, this is sterling having risen up to a level at 12446 with the highs we saw recently back on the 18th of January.

Since then, there's been a little bit of consolidation going on, same sort of thing. If you're looking at a dovish Fed, you'd be taking this up. In other words, you'd be long with a stop below recent price action.

If you think that there's going to be an aggressive Fed, then obviously you would expect this market to move lower on the session around that decision tonight from the Federal Reserve.