USD remains a tough sell even with a dovish Fed outcome USD remains a tough sell even with a dovish Fed outcome USD remains a tough sell even with a dovish Fed outcome

USD remains a tough sell even with a dovish Fed outcome

Forex 4 minutes to read
Charu Chanana

Head of FX Strategy

Summary:  While headlines could suggest that the Fed meeting remains a non-event, we are still tuned in for any dovish hints. More confidence in the path of inflation could spell real rate concerns, and more elaborate QT fine-tuning discussions could also be key. However, these signals may not be the green light that dollar bears are waiting for, with weak ex-US growth and seasonality still keeping the dollar a buy on dips.

The key theme running in the markets right now is that of disinflation. However, the US economic resilience continues to defy expectations, boosting Goldilocks. Goldilocks, a reference to the fairy-tale, refers to the current macro conditions being neither too hot nor too cold. It is the perfect scenario where growth and inflation are cooling, but not too fast to raise any recession risks. In essence, it is the soft landing scenario that every central bank hopes to achieve.

However, it is worth noting that soft-landing hopes usually pick up before an actual recession. We talked about the divergence between the signals from hard and soft economic data out of the US in this article, and unless hard data starts to show weakening trends, markets may continue to bet on a soft landing. Market expectations of the March meeting also confirm this confusion, with 50% odds seen for a rate cut cycle to begin.

With this macro backdrop in place, let’s understand what to expect from the FOMC meeting this week, and how that can move the FX markets.

FOMC will likely be a non-event on the headlines

The Fed meeting is expected to result in no change in interest rates or guidance. Will that mean FOMC meeting is a non-event? Focus will be on the post-meeting press conference from Fed Chair Jerome Powell. Our Head of Fixed Income Strategy has published an FOMC preview, and our key views are summarized here:

  • The rotation in Fed voting committee sees the addition of more hawkish members such as Mester, Bostic, Barkin and Daly. Recent commentaries from these new members have tilted hawkish, with Mester explicitly noting that March is too early for a rate cut in her view, while Bostic outlined Q3 as his base case for the first cut. Barkin has not specified a timeline for cuts but noted that progress on inflation has remained narrow and focused on goods while Daly said it’s “premature” to think that rate cuts are around the corner.
  • Disinflation and growth resilience means there may not be an immediate pressure on the Fed to act and data-dependency will likely be emphasized. However, any optimism about progress on inflation will bring the focus back to increasing real rates (nominal rates – inflation) which will prove to be unnecessarily restrictive and could be threat to real growth in the coming quarters. This suggests that being increasingly comfortable with inflation will be a dovish signal for the markets.
  • The other dovish signal in the FOMC can come from more elaborate QT discussions. Tweaks to QT are likely to come ahead of rate cuts.

FX market implications

With the risk/reward tilted towards a dovish Fed outcome, the next question is whether it could bring dollar downside? As we have argued before, an entrenched bearish dollar trend needs to meet two conditions:

  1. an easing Fed cycle
  2. strong ex-US growth

While we may be getting close to the first one here, dollar remains a tough sell because of worse economic conditions in other major economies and the high yield that USD continues to offer for now.

Tactically, the FOMC meeting could be a dollar negative, and high-beta FX pairs such as AUD and NZD could benefit, along with GBP that has been holding up well due to the expectation that BOE could have room to stay hawkish for now. However, event risk from BOE meeting on Thursday could cap gains in sterling. EM FX and Gold/Silver could also be the beneficiaries of lower yields and dollar.

But more importantly, dollar remains a buy on dips with hard landing risks seen rising in the Eurozone or also Canada if their central banks delayed easing measures into H2. This continues to point towards a bearish outlook for EUR and CAD, although oil price risks could keep CAD supported for now. DXY index could find support at the 50DMA at 102.92, with EURUSD could take another stab at breaking below the 1.08 support with 100DMA at 1.0779 coming in view.

Source: Bloomberg, Saxo

Still, worth noting that equity sentiment is a key driver of FX markets lately, more so than yields, and the megacap earnings announcements due this week could remain a key driver for where the dollar goes. As a general rule, earnings outperformance could boost equity markets and risk sentiment, and that is a dollar negative. Any risks of misses in the earnings announcements could weigh on the broader equity sentiment, and that could bring a safety bid to the dollar. So, dollar exposure can serve as a hedge against portfolio risk tilted towards big tech earnings this week.

Seasonality also supports a strong dollar

Start of the year is also seasonally a strong one for the dollar, as a recovery for the decline at the end of the year. The simple explanation for this is that most US companies usually transfer out cash to the balance sheet of their overseas subsidiaries at the end of the year to save on tax liabilities. The smaller the amount of cash on their balance sheet at the end of the year, the lower their taxes. This results in a seasonally weak dollar at the end of the year, and the start of the new year usually brings some bit of a reversal for this trend as companies likely transfer sizeable amounts back to the US. As the chart below shows, DXY returns in January and February have averaged 0.4% and 0.3% respectively in the last 23 years. Worth noting however that the decline in USD in December 2023 was 2.1%, much worse than the average of -0.9%. Consequently DXY is looking to end the month with MTD gains of 2.1%, against average of 0.4%. This could imply strong gains in February as well, before the tide turns.


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