The market’s full focus is now on the FOMC meeting. At today’s meeting, the dot plot and economic projections will be updated. Because of that, the rate cut path will become clearer for market participants.
The US economy is performing relatively well compared to both the Eurozone and its own historical averages. Despite the high rates, US growth was near or above average in the previous quarters. However, recent activity data somewhat indicates a possible limited slowdown might be imminent.
Inflation remains the number one worry for a possibly hawkish FOMC. Recent data was hotter than expected, perhaps due to strong growth and a tight job market. The upward momentum in oil markets is not helping the situation either. If oil prices stay high for a while, the upward pressure on inflation might intensify. Most of the pressure on inflation is still coming from the tight job market, relatively persistent housing prices and strong services sector. Although the trend of inflation is showing signs of decline, the trend of supercore inflation seems to be ending, which will be a point of caution for the members.
The job market is still tight, with unemployment at historically low levels and the US economy creating around 200k new jobs every month. The participation rate is on the rise, and wage growth is still higher than what the Fed wants. Despite this outlook, the tightness of the jobs market is gradually decreasing.
In light of this economic outlook, the Fed will update the economic projections. The key points to watch are:
- Dot plot: The main focus will be on the Federal Funds Rate projection. The current one is pointing to 3 cuts this year. Traders will be watching to see if any members change their projection to 2 cuts. If the median projection changes to two cuts, this will be seen as hawkish.
- Inflation is running hotter than expected. This might also change the projections. An upward change will be positive for the dollar index. We expect a 0.1% upward revision to both PCE and Core PCE.
- Activity data since the December FOMC is showing a slight slowdown. A possible downward revision surprise to GDP can be seen as dovish. However, strong third and fourth quarter GDPs suggest that the likelihood of a downward revision is not too high.
- Some members have talked about slowing down QT in recent weeks. The fall of the reverse-repo balance is seen as a sign that liquidity in the markets is decreasing a little too fast. We do not expect a decision about QT, but Powell might update the markets about possible discussions about it. If no QT talk is planned, this might be seen as hawkish, and if Powell states the possible slowdown of it, this might be seen as dovish.
(Dollar Index Daily Chart)
Since the final months of 2022, the dollar index has been moving flat between 101 and 107. Initially, in July, this horizontal zone was tested to the downside, and the dollar index even fell below 100 for a couple of days. Then, with a sharp turnaround, the dollar hit the 107 ceiling and tested it multiple times. Since then, the index has been contracting in a triangle formation.
The index tested the triangle’s upper line in February then turned towards the south. But instead of falling to the lower line, it is getting close to the upper line once again. The hotter-than-expected inflation data is the main reason for this. The recent bottom stays much higher than it is supposed to be in the triangle, and this might be a bullish signal for the dollar index.
The market expects a relatively hawkish FOMC, and most of the signals are in line with that view. A possible break of the triangle formation might trigger a bullish period for the dollar, which is negative for cryptocurrencies, stocks, precious metals, and EURUSD. However, a dovish surprise from the Fed on top of a no-change dot plot might cause a different scenario to happen.
