The US Federal Reserve will announce the results of the May meeting on Wednesday. Perhaps this is the most significant event of the current month for traders of the foreign exchange market. The US central bank will not only raise the interest rate (which there is no doubt about), but will also determine the further algorithm of its actions. And if the Fed members announce aggressive rates of monetary policy tightening, we will witness another dollar rally. In the case of the EUR/USD pair, this may turn into a price decline in the area of 20-year lows, that is, in the area of 1.0350. But if the central bank does not justify the "hawkish aspirations" of market participants, bulls will organize a corrective growth, returning the price to the area of 6-7 figures. And yet, judging by the previous statements of the Fed's members , the bearish scenario is the basic one.
First of all, it should be noted that the market has actually won back a 50-point rate hike at the May meeting. This event is fully taken into account in prices, so it will not cause any commotion. The intrigue of the May meeting is different. In fact, we are interested in two questions: the further pace of interest rate increases and the timing of the start of the Fed's balance sheet winding down.As for the rate, there is no consensus among experts and currency strategists of the largest banks. According to some analysts (in particular, Barclays), the central bank will raise the rate by 50 points in May and in June. Next, the Fed will reduce the pace to a 25-point step. This is, let's say, the most "popular" forecast, which sounds more often than all other assumptions. However, Barclays strategists make an important reservation here: the Fed will reduce the pace of rate hike from July only if they see signs of slowing inflation.
According to other analysts, the US central bank will tighten monetary policy in 50-point steps at each meeting until September (including the September meeting).
The most hawkish scenario (which, however, is rarely voiced) is a 75-point rate hike at the June meeting. Also, the option of a 75-point increase at the May meeting is not excluded. Let me remind you that the corresponding initiative was made by the head of the St. Louis Federal Reserve, James Bullard, who this year has the right to vote in the Committee.
Thus, despite the fact that all the predicted scenarios of the May meeting are hawkish, the degree of hawkishness still varies. If the Fed limits itself to a 50-point rate hike and takes a rather cautious position on further steps (pointing out, in particular, the factor of geopolitical instability), the dollar will sink throughout the market, including in pairs with the euro (the pair may jump to 1.0650-1.0700). But in my opinion, this is an extremely unlikely scenario.
The "basic" scenario (a 50-point rate hike + the announcement of a similar step at the June meeting and in the future, according to circumstances) will allow EUR/USD bears to settle in the area of the 4th figure. However, such a scenario is unlikely to allow them to go lower, to the notorious support level of 1.0350. In my opinion, the pair will decline into this price area only if the "ultra-hawkish" scenario is implemented: a 75-point rate hike at the May meeting (or the announcement of such a radical step). Also, the central bank may allow the option of a 50-point rate hike at each meeting until the fall. In this case, EUR/USD bears will not only be able to gain a foothold within the 4-figure, but also test the support level of 1.0400.
As for QT, it is worth recalling here that most recently the head of the San Francisco Fed, Mary Daly, announced that the central bank could start reducing the balance sheet as early as June. At the same time, it was indicated in the minutes of the March meeting that the Fed is ready to implement a "faster" pace of reducing the size of the balance sheet than in the period 2017-2019. The minutes states that the central bank will begin to reduce assets on the balance sheet in increments of $95 billion per month ($35 billion in mortgage-backed securities and $60 billion in U.S. government bonds). For comparison, it can be noted that in 2017-2019, the scale was $50 billion per month, and it took the Fed about a year to bring the target to this.
Summarizing what has been said, it is necessary to make an important remark: any scenario implemented by the Fed will play into the hands of EUR/USD bears. Even the "weakest" scenario will strengthen the divergence of the positions of the Fed and the European Central Bank, and this fact will put significant pressure on the pair. The ECB is still voicing cautious rhetoric, even despite the record increase in inflation in the eurozone. Recently, ECB Vice President Luis de Guindos said that a rate hike in July is "possible," but he added that it is "unlikely." ECB President Christine Lagarde is also showing similar caution, who doubts that core inflation will grow at the same pace in the second half of the year.
All this suggests that it is advisable to use any corrective pullbacks on the EUR/USD pair as an excuse to open short positions. After all, the euro is under pressure from other circumstances, ranging from the energy crisis to geopolitical tensions. Therefore, the greenback will gain momentum, including due to its status as a protective asset.
The first target of the downward movement is the 1.0450 mark (the lower line of the Bollinger Bands indicator on the D1 timeframe). The main target is located below – this is a psychologically important support level of 1.0400.
