Fundamental Analysis: Slight Losses for the Dollar ahead of the Fed

Fundamental Analysis: Slight Losses for the Dollar ahead of the Fed

The dollar has weakened against most major currencies so far today. The small movement downward by the dollar comes in the runup to the crucial announcement this evening by the Federal Open Market Committee. Slightly weaker data yesterday and last week from the USA has also driven losses to some extent.

Euro-dollar at $1.135 is close to three-week highs, and the dollar has also lost marginally against the yen to about ¥111.53. Cable though has declined today to $1.323 at the time of writing, with Brexit-related uncertainty being an important factor.

Timeline of events

  • 18.00 GMT: FOMC's statement, rate decision, and economic projections
  • 18.30 GMT: FOMC's press conference

Rates in 2019: an overview

The announcement of any change in the funds rate tonight from the current 2.25-2.5% is essentially off the table. However, the comments during the subsequent press conference are very important for the dollar’s performance in the near future.

The Fed’s projection materials are designed to indicate the most likely scenarios for the American economy in the future. Usually traders look at these to determine when the next changes to the funds rate might occur. In this case, the trend of the projections is likely to be slightly downward. This might suggest that the Fed will indeed slow down its program of rate hikes.

Current expectations among analysts are only around 25% in favor of a rate hike by the Fed in 2019 according to CME Group’s FedWatch. Based on the same source, the likelihood of holding rates is 98.7%, with a 1.3% chance of a cut tonight.

Weaker data and the Fed’s caution

Economic releases from the USA have overall been slightly lower over the past few weeks. Yesterday’s main event was monthly factory orders for January, which was static at 0.1% and missed the consensus by 0.2%. Last week’s annual CPI release at 1.5% was also 0.1% lower than the previous release and the consensus.

Other data like PPI and durable goods was also negligibly lower than expected. Ultimately, these recent releases do not indicate a major slowdown in the USA’s economy. However, many traders and analysts expect the Fed to acknowledge that growth isn’t quite as good as it was last year.

Where to for the balance sheet?

In light of the near certainty of a hold in rates, traders might focus more than usual on the Fed’s large balance sheet. Currently the Fed is reducing its holdings of Treasury bonds and mortgage-backed securities by about $40 billion each month.

Some expect the Fed to announce or hint at a slowing of these reductions. If this is the case, traders would have a better understanding of how much longer the balance sheet will continue to shrink. More importantly, they might have an idea of which assets the Fed would continue to hold at the end of the process.

Volatility for the dollar but probably little direction

Based on current circumstances and the expected course of events tonight, a clear and sustained movement by the dollar remains unlikely. Slowing growth and the very low likelihood of a rate hike mean that the chance for gains in USD is small. Equally, differentials in rates with all other major currencies make any significant decline for the dollar unfavorable. What is probable though is very high volatility in currency markets around the announcement and press conference.

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