The June Federal Reserve meeting is the most important event of the month. Central bank rate decisions are always significant but updated economic projections and dot-plot forecasts will also be released. Fed Chairman Powell will hold a press conference where reporters will undoubtedly pressure him for details about his recent comments. Earlier this month, Powell said the economy is growing but given trade developments, they will “act as appropriate to sustain expansion.” While he never used the words “rate cut,” investors rushed to price-in easing. Fed fund futures are calling for a 95% chance of a quarter point cut in September. Back in March, the dot-plot forecast dropped from two to zero rate hikes this year. At the time, 11 out of 17 policymakers felt that additional tightening was not necessary in 2019. This dramatic shift was a result of their concerns for low inflation, household spending and business investment. In May, Fed Chair Powell put on a brave face and dismissed talk of easing by saying policy stance is “appropriate right now” and “we don’t see a strong case for moving in either direction.”
How the U.S. dollar reacts will depend on whether Powell repeats this line or replaces it with language that validates the market’s forecast for a rate cut. In reality, we think that unless stocks fall another 15-20% or job growth turns into job losses, the Fed will keep interest rates unchanged for the rest of the year. There hasn’t been a significant slowdown in the labor market, retail sales increased in May and spending in April was revised from negative to positive. Equities are still attracting buyers, Chinese data has been stable and the strain on the U.S. economy is only beginning to appear. The decline in U.S. yields also helps the economy. For all of these reasons, Powell may not be particularly dovish because even when he suggested that they could take steps to sustain the expansion, he described the economy as growing, said unemployment is low and inflation stable. The Fed has no immediate plans to change interest rates, which should be the main takeaway from this month’s meeting. However we could be wrong and Powell could talk about the possibility of easing because according to the table below, there’s been widespread deterioration in the economy since the last policy meeting. The remaining 6 policymakers that favored a rate hike in 2019 could also flip their views.
When it comes to trading FOMC, the main focus should be the dot plot and Powell’s guidance. If 3 or 4 additional policymakers support no hikes this year OR some members favor a cut, we could see the dollar fall sharply, especially if that forecast is reinforced by cautious comments from the Fed Chair. In this scenario, USD/JPY will drop as low as 107.50 and EUR/USD could break above 1.1350. However if Powell puts on a brave face, emphasizes the areas of strength in the US economy and the dot plot/economic projections remain mostly unchanged, we could see a significant recovery in the greenback that could take USD/JPY above 109 and EUR/USD to 1.10.
In the event of a less dovish Fed, the euro could be hit the hardest because European Central Bank President Draghi said more rate cuts are part of the ECB’s toolkit and “if the outlook doesn’t improve additional stimulus will be needed,” sending EUR/USD sharply lower. The possibility of additional easing is reinforced by weaker data. The expectations component of the Eurozone ZEW survey fell to its lowest level since January while the German component dropped to an 8-month low. Consumer price growth also slowed as the trade surplus narrowed. All of this follows the Bundesbank’s warning of a Q1 contraction in the region’s largest economy. So if the Fed does not suggest that rate cuts are possible, the ECB’s intention to ease could drive EUR/USD to 1.10.
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