EURUSD inches up ahead of Fed decision: FOMC preview

EURUSD ticked up slightly Wednesday ahead of the FOMC meeting although it remains decidedly held in check by the ever-narrow range as traders wait for this week's two big risk events in the shape of the FOMC and ECB announcements. But the prospect of a cautious ECB and slightly more hawkish-than-expected Fed could turn into a bearish breakout back towards the 1.15 levels.

In terms of the Fed, a hike is a done deal already so as ever the focus is less on today's decision but on the language in the announcement, the tone struck by Jay Powell in the presser, the dots and the economic projections.

Barring a major upset, the FOMC will vote to raise rates by 25 basis points, the seventh time in the current hiking cycle. The big question for the markets is whether the median dot plot points to 4 hikes this year or 3 as per the March data, and how many do we get in 2019.

Following yesterday's inflation data, the market seems to be assigning a greater probability that the Fed will go four times in 2018, although the odds are still less than evens and this reflects the Fed's fairly dovish approach in terms of its inflation target. It is likely that Powell will stress the symmetric nature of the target, i.e., that it is happy to allow a few hot summer inflation readings go and won't see a slight overshoot in inflation as a reason to accelerate the pace of tightening significantly.

Nevertheless, it won't take much for the median dot to signal 4 hikes and as such with USD off its late May highs there could be room on the upside. We can also identify more positive economic data since the March projections and that could force the Fed to raise its forecasts for rates. Market pricing will probably have to reflect more chances of 4 hikes this year. But as know, dots are show, hikes are for dough and a 4thhike signalled in 2018 may not be terribly hawkish.

Of particular note, markets will focus on where the Fed thinks the neutral rate will be – are we are nearly there yet or does the growth point to a higher terminal rate. Does a fourth hike this year simply get us there quicker or does the Fed see this as necessary to maintain the gradual pace of tightening? If the Fed is ready to go above this neutral rate it would be a pretty hawkish move and USD could stiffen. This question should be answered in the dots but it's worth noting that this is arguably more important than whether it's 3/4 this year. A more aggressive pace of tightening without a signal that the long-term rate will be higher could upset markets and produce further flattening in the yield curve. The risk of further flattening and ultimately inversion remains probably the biggest argument against 4 hikes in 2018. Stronger language on the neutral rate could help lift yields further along the curve and ultimately it does look as though the Fed is ready to go beyond neutral in this cycle. The market may therefore need to reprice if confirmed.

Focus will be on the language in the statement that maintains that the fed funds rate "is likely to remain, for some time, below levels that are expected to prevail in the longer run." As per comments from Lael Brainard and May meeting minutes, some revision to forward guidance is expected.