FOMC preview: US dollar in focus amidst rising risks

Conflicting ‘lightweight’ central bank decisions with India, New Zealand, and Thailand reducing rates but Australia, Canada, and Sweden keeping them on hold, last week’s ‘heavyweight’ European Central Bank (ECB) decision shook markets following a reduction in its deposit facility rate to -0.5% and a simultaneous bond purchasing program to counter rising recessionary risks and dismal Eurozone data. That has set the stage for what will be a string of central bank announcements this week, with the focus chiefly on the US Federal Reserve’s Open Market Committee (FOMC) to see whether it’ll match current market expectations.

When is the Fed’s monetary policy announcement set to take place?

The The Federal Reserve’s (Fed’s) monetary policy announcement is this Wednesday, 18 September, and will feature not just its interest rate, statement, and press conference from its Fed Chairman Jerome Powell, but also economic projections. Much has changed since the Fed’s last meeting on 31 July where it introduced a 0.25% rate cut for the first time in 11 years as a ‘midcycle adjustment’ and not as the start of a monetary easing to deter markets from pricing in further rate cuts. But it was a hard sell especially as US trade risks have failed to subside with both US and China imposing fresh tariffs on each other since then, even if talks are planned for October and goodwill gestures made prior.

In terms of US data, it’s been a mixed bag with Institute for Supply Management (ISM) manufacturing purchasing managers index (PMI) contracting for the first time in three years, the latest Non-Farm Payrolls report mixed, and both retail and services PMI impressing. Both consumer price index (CPI) and payment protection insurance (PPI) figures were higher than expected, though the wild card is this past weekend’s attack on Saudi oil plants that have caused oil prices to surge and could result in higher inflationary figures down the road globally, making it more difficult for central banks to pursue easing policies that have a tendency to send prices higher – especially asset prices.

And then there’s the US president Donald Trump, who tweeted that the ECB’s decision to cut rates and weaken the euro would hurt US exports and saying that the US central bank should reduce rates to ‘ZERO, or less’. The differing circumstances between the ECB trying to avoid a recession and the Fed trying to sustain the expansion buoyed by increased fiscal policy doesn’t factor into attempts by the current administration to reduce the US trade deficit, which is set to be a tougher task should other central banks follow the ECB in pursuing their own easing programs.

Expectations heading into the Federal Reserve’s monetary policy announcement

As it stands, markets are majority – but no longer fully – pricing in a consecutive 0.25% rate cut out of the Fed, and such a decision wouldn’t be a difficult outcome for the US central bank even following Powell’s comments that unanimity would be difficult in the current internally divided atmosphere amongst committee members. There is also the possibility that should the Fed not impress the US government in easing enough, President Trump can always resort to doing what he did on 1 August the last time around he felt the central bank didn’t do enough: announce fresh tariffs on Chinese imports and cause the trade war to worsen, in turn forcing the Fed to reduce rates on increased trade risks.

In all, the event is set to be a volatile one not just on Wednesday as markets absorb the monetary policy adjustments (if any), forward guidance, and Powell’s tone for any hints of dovish talk in the current atmosphere, but the days following it to see if it’ll provoke a reaction from the US government in its trade war with China and other central banks like the Bank of Japan (BoJ), Bank of England (BoE), and Swiss National Bank (SNB) who are all set to announce their monetary policies on Thursday with expectations for them to keep rates on hold.

US dollar retail and institutional sentiment

In terms of sentiment, the latest Commitment of Traders (CoT) report shows the bias for the US dollar index in heavy long territories at 74%, up 3% on the week before on similar 5000 lot reductions in both long and short positioning. And they remain majority short the remaining FX majors (that are against the greenback) with the exception of the safe haven Japanese yen switching to majority long in late July anticipating further risk-off plays and the Canadian dollar. Retail bias is majority short 59% and set to rise should any further price increases occur and entice dwindling longs into taking profit.

The US dollar’s weekly and daily technical outlook

From a technical standpoint, the weekly mid-term outlook has been relatively consolidatory and range-bound, with a bull trend channel on the weekly managing to loosely hold, and where its price is above all its main weekly long-term moving averages, with a positive (directional movement index) DMI, piercing the upper extremes of the band, and showing an ongoing propensity to trend via its average directional index (ADX). On the daily however, more of its technical indicators have been turning neutral, with its price below all its main short-term moving averages, above all its long-term MA’s, a negative DMI cross occurring on Friday, and combined with a trending ADX.

How to trade the US dollar index

But with such a fundamental event, both technicals and sentiment hold less relevance, especially as its price is set to get volatile, and entice contrarian breakout strategies over conformist reversals.

That means setting to buy the first resistance level at 98.19 with a stop loss of 97.92 and a take profit of 98.73, and selling the first support level of 97.11 with a stop loss of 97.38 and a take profit of 96.57.
Those looking to trade with a more contrarian point of view can consider buying the 1st Support level after a significant reversal (waiting for the level to break first and buying as it retraces back up) for a take profit of at least 97.65 and a stop loss of 96.84, or selling the 1st Resistance level of 98.19 for a take profit of 97.65 and a stop loss off 98.46 and doing so after a reversal (waiting for the level to breach first and selling it as it retraces back down).

Given the expected increase in volatility this week, fading strategies (trading counter to a move) should be avoided as they will be most prone to being stopped out.