Dollar Hollar: USD Index Holding Pattern Ahead Of FOMC

Dollar Hollar: USD Index Holding Pattern Ahead Of FOMC

USD Index has pared gains ahead of tonight’s FOMC rate decision. Markets don’t expect any rate move so markets are more concerned with the statement parcing the language to see if the Fed will strike a cautious tone, given recent market turmoil. Markets will be watching for hints on US inflation outlook, given renewed crude price collapse and recent rhetoric from FOMC voters (Bullard, Dudley).

Fundamental Flows

The USD has rallied impressively on a broad, trade weighted basis to start 2016 even as market participants have priced in a more accommodative outlook for the FOMC. This likely reflects the reality that a reduction of one, or more, interest rate hikes in the US may not be enough to derail broader concerns such as oversupply in energy markets and slowing Chinese growth. It likely also reflects recent dovish surprises (or rising expectations of such) from several other major central banks – such as the ECB President Draghi’s signals of new easing, BoE Governor Carney’s dovish “Turn of the Year” speech, large PBoC liquidity injections, the BCB surprise rate hold, and a potential BoJ QQE expansion this week. These dovish turns elsewhere may have added to the sense that the FOMC will likely employ a dovish tone this week as well. As a result, the risks of an out sized reaction on a hawkish surprise

From a market perspective if the FED treads the middle ground,  this will likely result in validating current dovish market pricing, though perhaps not add to it. USD has a mixed (perhaps slightly supportive) initial reaction but FX markets may simply continue to take their cue from broader risk sentiment.

A more dovish statement likely sees markets quickly price out expectations for rate hikes in 2016 as the USD slips across the board. The formalization of concern over second round effects of inflation expectations would be a new, dovish signal. Emerging markets rally strongly.

A hawkish statement would suggests the Fed’s communication looks increasingly at odds with the dovish turns of other major central banks – monetary policy divergence is still a dominant, USD-supportive theme, and the USD rallies across the spectrum. USDJPY longs may prove tricky, as the decision to expand QE in Japan appears to hang enough in the balance, and a Fed-induced stronger USDJPY could potentially tip the scales. EURUSD shorts preferred.

The presence of hawkish and dovish elements may leave the market reaction a bit muddied. Though the risks of an out sized move on a hawkish surprise outweighing the risks of an out sized move on a dovish surprise, given current market pricing, the USD may rally initially on the more firm signal about a potential rate rise in March.

Technical & Trading Takeaway

From a trading perspective I retain bullish exposure in the USD Index from .9700 ultimately I am anticipating a topside thrust from the consolidation pattern we are trading in at the moment. This top side thrust should act a s near to medium term terminal move, from which we should anticipate at a minimum a correction to the recent advance this correction can provide a platform for traders to re-engage the broader upside advance. However, the current consolidation pattern is mature and may now be developing a rising wedge pattern in the near term which would likely produce another corrective leg. If price breaks lower from current levels here is the market map of the probable path of price I will be using to re-position as highlighted in the chart below I would be watching for an equidistant swing to retest the apex of broader consolidation pattern which at the 95.00/96.00 level where I would be looking to re-enter long postilions to trade the upside pattern mapped in the chart, ultimately price would still test the 102/103.

2016-01-27 13_54_29-2016-01-20-12_25_37-.png (PNG Image, 1916 × 1021 pixels) - Scaled (98%)

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