Fed preview: volatility ahead as FOMC are urged to react on weak data

This week has a host of central bank appearances for traders to contend with, as the Bank of Japan (BoJ), Bank of England (BoE), and Federal Reserve (Fed) all providing their latest monetary policy decision. However, for the most part traders are only concerned with one event, as the past week of huge dollar volatility will testify to. The Fed have been raising rates since 2015, yet considering the prior lull, we have not seen rates cut since 2008. Over a decade later and markets are expecting that we will finally see the Fed reduce their headline interest rates once more after a clear slowdown in economic data points.

US economic slowdown

The US-China trade war was relatively slow to impact the US economy, yet we have seen a clear detrimental impact over recent months. Firstly, one of the biggest and most clear-cut issues has been the decline in US gross domestic product (GDP), with growth slowing to 3.1% in the first quarter (Q1) of 2019, down from a peak of 4.2% in Q3 2018. This is part of a wider trend, with global growth shifting downwards as global trade hits the buffers. The ongoing trade war is also denting business confidence, helping drag expectations for future growth. And with the sharp decline in both the ADP and headline payrolls figures seen last week, the chorus of calls for a US rate cut is becoming increasingly loud. Certainly, the Fed story is always going to be double sided, with the trajectory of growth counterbalanced by the direction of US inflation. With inflation (1.8%) remaining below that crucial 2% level, the downward trajectory of energy prices points towards a continuation of that below-target inflation story.

Ultimately there seems to be a clear understanding that the Fed moved too quickly with their rate rises, with huge trade war clouds continuing to hang over the US economy. However, this month represents a particularly interesting moment for the Fed, with markets pricing in a mere 20% chance of a rate cut. However, that 1 in 5 chance is tantalising from the perspective that it is both unlikely and a distinct possibility. The Fed will know that such a rate cut would not necessarily take markets by so much of a surprise that it would be deemed reckless. Fed members will also know that a rate cut at this stage would have a significantly greater impact than one implemented within a meeting where such a shift is largely baked into price. Thus, there is a chance that members will want to shock markets, driving the dollar down and having a beneficial effect for US exporters.

However, there are good reasons for the Fed to hold off this time around, with the G20 meeting widely seen as a potential breakthrough moment in US-China relations. With US President Donald Trump and Chinese President Xi Jinping expected to meet at the summit, the Fed will understand that a deal between the two sides would lessen the need for action from it. It is also notable that the preliminary GDP reading for Q2 will be released before the next Fed meeting. Federal Reserve chair, Jerome Powell’s appearance back in early June saw him lay out a willingness to ‘act as appropriate to sustain the expansion’. Thus while we are seeing a decline in economic indicators for the second quarter in the US, the ultimate impact on GDP is yet to be seen.

Finally, whether or not we see a shift in US rates, traders will be keeping an eye out for the subsequent comments on Wednesday. Markets are currently pricing in a 67% chance that rates will be cut by at least 50 basis points in the next three weeks. Thus, those expectations are there to be shifted and shaped by Powell’s comments on Wednesday.

Dollar rises from trendline support

The dollar has seen a ramp up in volatility over recent weeks, with last week seeing a particular surge for the greenback. The rising wedge formation seen throughout the past nine months points towards a likely breakdown before long, and given the tightening expected from the Fed, such a dollar breakdown would make sense. However, we need to break through $9.594 to bring about that bearish picture for the dollar index. We are currently trading within another ascending phase within this pattern, yet Wednesday will likely shape market expectations greatly.

The four-hour chart sees the dollar turning lower today, following on from a rally into trendline resistance. The break through $96.93 points towards a likely second leg higher before long, yet with the Fed expected to greatly impact market expectations it makes sense that such a leg higher may not come. As such, the short-term picture is dictated by whether we can break through this resistance zone, with Wednesday’s meeting providing us with the possibility of a bearish picture coming back into play for the dollar.