Watch the Fed's "S" Word

FXStreet Team FXStreet

The Fed decision is due at 14:00 Eastern Time, 19:00 London, and is widely expected to raise the Fed Funds rate by 25 bps to the new range of 1.75%-2.00%. The immediate USD reaction will be in function of the number of additional rate hikes signalled by the dot plot forecasts. Expect USD to decline specifically against AUD, CAD, NZD and EUR in the event that only one additional hike is forecast for the year. But if...

If two or more rate hikes are signalled, then expect a knee-jerk climb in the USD, especially against EUR, JPY and CHF, yet the gains will likely dissipate once Fed Chair Powell begins his press conference 30 mins later. Why?

The “S” word

Fed chair Powell has not only spoken of his lack of enthusiasm for the dot plot forecasts for their suceptibility to change and long term nature, but most importantly he will likely be asked about the Fed's symmetric approach to inflation reiterated in the last 2 FOMC statements. A symmetric objective to inflation means the Fed anticipates inflation to reach the 2.0% target and is willing to allow it to edge towards 2.5%, just as it has allowed to undershoot to as low as 1.4% last summer. Recall that the Fed's inflation gauge (core PCE) stood at 1.8% y/y in March and April.

Said differently, just as the Fed did not interrupt its campaign of gradual tightening when inflation fell below target last year, it will not necessarily accelerate the frequency of rate hikes this year when inflation reaches 2.2% or 2.3%.

The Usual Bonds Argument

As the Fed sells more treasuries to reduce its balance sheet & US govt issues more bonds, the Fed cannot afford to maintain the same rate of pace of interest rate hikes, otherwise, it risks triggering a rapid ascent in bond yields. Holding back on price tightening (Fed hikes) will also be consistent with the Fed's symmetrical assessment for inflation i.e. allowing inflation to run towards 2.3% and event 2.5%. This is exactly what gold bulls will want and USD bears are waiting for We have a list of existing trades for

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