FOMC preview: rising yields and inflation outlook could drive dollar resurgence

The Federal Open Market Committee (FOMC) are back in the fray this week, with the latest two-day meeting set to conclude on Wednesday 17 March.

Yields a key concern of late

The Federal Reserve (Fed) meeting comes at an opportune time for the markets, with the recent rise in treasury yields highlighting a major shift in economic expectations as the world reopens.

That rise in yields has been key in damaging tech stocks, and that will be a key market to watch on Wednesday. As a rule of thumb, rising 10-year yields often see value and pro-cyclical stocks perform well, while growth stocks and gold suffer.

Recent commentary from Jerome Powell signals that the Fed Chair sees this rise in yields as being somewhat normal given the current situation.

However, with the European Central Bank (ECB) shifting their pandemic emergency purchase programme (PEPP) purchases forward in a bid to alleviate the recent rise in yields, there is clearly a feeling that other banks could follow suit in an attempt to bring borrowing costs down.

What changes at this meeting?

The recent ramp up in vaccination effort have lifted sentiment for an economic bounceback, with US president Joe Biden’s $1.9 trillion stimulus package bringing greater expectations around the US economic performance in particular.

That has led to a raft of growth upgrades, with the likes of the Organisation for Economic Co-operation and Development (OECD) and Goldman Sachs both lifting their 2021 and 2022 outlook over the past week. Nevertheless, from a monetary policy standpoint, we are unlikely to see much change given the ongoing uncertainty and relative infancy of this recovery.

That means we expect little movement on the Fed funds rate (<0.25%) and QE programme (monthly purchases of $80 billion treasuries and $40 billion mortgage-backed securities).

One area of interest comes from the Fed dot plot, with the release of this key forecast tool coming for the first time since December. Much has changed in that time, with Joe Biden moving into the White House, vaccination efforts ramping up, and the $1.9 trillion stimulus package gaining approval.

That stimulus package in particular does raise significant risk of a sharp rise in inflation over the coming year. Thus, markets will be highly sensitive to any changes in the outlook for interest rates rises at the Fed.

After all, the recent rise we have seen for the dollar is likely a result of expected interest rate and treasury yield differentials.

With the US stimulus package expected to drive faster growth and higher inflation, traders will be keen to understand whether their presumption that the Fed may move first are well founded. With that in mind, traders should keep an eye out for the latest dot plot and economic projections.

Dollar index technical analysis

The dollar has been enjoying somewhat of a resurgence of late, with the dollar index moving into its third month of upside.

Looking at the monthly chart we can see the gradual shift in momentum, with the stochastic clearly in the process of bottoming out after an extended period of downside.

The past 13 years have brought about five occasions where the stochastic has passed back up through the 20 threshold after a period of being ‘oversold’. Each such break has brought about an extended period of upside, averaging ten months of subsequent upside.

With that in mind, there is a good chance we are on the cusp of another such period of extended upside for the dollar. Interestingly, this latest recovery appears to be coming from a zone of support that provided the last bullish reversal swing back in 2018.

From a daily perspective, the recovery we have seen thus far takes us towards a cluster of Fibonacci and simple moving average (SMA) resistance. From this perspective, there is still a chance we turn lower before long to continue the ongoing downtrend.

However, a break up through the 94.79 resistance level ends this trend, bringing about a more confident long-term bullish outlook for the dollar.