Fed Preview: Three scenarios for the crucial dot-plot and four other things to watch

• The Fed decision is centered on the dot-plot after the Fed pledged patience. 
• Announcements about the balance sheet, a reaction to jobs, and inflation are also of interest.
• The US Dollar is set to move quite a bit, except against one currency.

The Federal Reserve announces its decision on Wednesday, March 20th, at 18:00 GMT, alongside the updated economic projections known as the "dot plot". Fed Chair Jerome Powell will hold a press conference at 18:30 GMT.

Why the dot-plot is important

After the Fed pledged patience on interest rates, the focus is on how it translates into the updated projections. The Fed introduced "patience" in January but new forecasts are due only now.

Powell's press conference is slightly less important. He holds a presser after each rate decision and makes quite a few public appearances, so while his post-rate decision presser is significant, the markets will likely move more on the changes to the interest rate projections known as the dot-plot.

The last time that the world's most powerful central bank published forecasts were in December 2018. Back then, the Fed increased the interest rate but lowered the outlook for 2019: only two hikes instead of three, in what was then not deemed sufficient enough to serve as a dovish hike.

Since then, the Fed made a substantial dovish shift, pledging patience on rate increases and also offering a rethink of its balance sheet reduction program. The slowdown in China and Europe are seen as headwinds while the domestic economy is "in a good place" according to repetitive comments from Powell.

And while the Fed preaches patience, does it mean it is done raising rates this year? Powell responded with "it's a good question" to a question on the topic this week. The dot plot will help in providing an answer.

3 scenarios for the dot-plot and the dollar reaction

1) Gradual downgrade: A downgrade to one hike is reasonable and gradual, leaving the door open in case the global economy picks up again and the local economy continues looking good. In this case, the greenback may rise, but gains could be limited.

2) No hikes this year: A downgrade to zero would open the door would be a damaging downgrade for the dollar. The greenback would fall on growing speculation that the next move would be a rate cut, in 2020 or beforehand.

3) Shocking no-change: And if the Fed shocks markets by leaving the outlook unchanged at two hikes, the Dollar will be King again. This seems unlikely. 

4 other topics: balance sheet the two mandates, and the economy

1) Balance sheet reduction: After the dot-plot, the next topic to watch is the balance sheet reduction program, also called Quantitative Tightening. The Fed is currently shrinking its balance sheet that reached $4.5 trillion in the peak by not reinvesting maturing bonds. The process has accelerated and contributed to the jitters in stock markets.

Back in January, the Fed said it will examine the policy and officials hinted that the balance sheet reduction could end as soon as this year. They have also suggested that a detailed program may come soon. 

The market will want to see if Powell and his colleagues present a program. For the dollar, the sooner it ends, the worse it gets for the greenback as the number of dollars in circulation will remain elevated, thus making it less valuable. An end of the program at the end of the year seems to be the base case. Going to 2020 would be dollar positive and a near-immediate termination would be negative.

2) Is job growth slowing? Comments about the job market are of interest as well. While wages are rising, the recent gain in positions was a meager 20K. Will the Fed shrug it off or express concern?

3) Stable inflation? The other mandate matters as well: inflation has slipped lower but remains OK. Any change in inflation prospects in the economic projections or in the wording of the statement or the press conference will also make a difference. 

4) State of the economy: Last but not least, watch out for comments about the local and domestic economy. There are some tentative signs of stabilization in Europe and in China and the Fed's opinions matter. The US economy has seen improvements in the housing sector, but perplexing retail sales data. Any clarity about the Fed's thinking on the topic matters.

USD positioning

Recent economic data have been mixed and the mood about the trade is similar: talks are ongoing but a breakthrough is not that close. All in all, the greenback awaits the Fed's verdict and may move quite a bit in both directions, without any specific leaning.

There is only one thing to remember: the Fed decision is out around the same time as the third Meaningful Vote in the UK about May's Brexit deal, and ahead of the EU Summit that will discuss a delay to Brexit. Pound volatility has risen considerably and GBP/USD moves on every minor Brexit development more than major global events.

Cable may ignore even the might Federal Reserve. EUR/USD, USD/PY and the rest cannot and will not ignore it.