The Federal Reserve is set to announce its verdict on monetary policy.
Judging by Tuesday's fall in risky assets, led by US stocks and the euro, the markets do not expect anything good from the FOMC meeting.
According to the results of Tuesday's trading, the key indicators of Wall Street fell by 1% on average.
"The indisputable fact now is that the Fed is implementing one of the most aggressive rate hike cycles in history. This is confirmed by what we have seen this year, and this has historically weighed down the valuations of US stocks," Charles Schwab economists noted.
"Growth-oriented stocks make up a much larger part of the market today compared to the last era, when inflation exceeded 8%. If rising interest rates continue to depress the value of these stocks, and profit growth slows, then profit margins will have less room to grow. At the lows of mid-June, stocks discounted a lot of negative news. The recent weakness clearly reflects the still high inflation and the "don't fight the Fed" attitude," they added.
Charles Schwab strategists expect the S&P 500 index to remain below the resistance zone of 4330-4400.
"Now the US central bank recognizes that it may have to admit greater economic and/or market harm in order to bring down inflation, while the volatility/weakness of the stock market is unlikely to cause a change in the central bank's policy. Resistance is somewhere between 4330 and 4400 on the S&P 500, a range that represents a key hurdle," they said.
At the end of the last five days, the S&P 500 lost about 4.8%, which was the worst weekly drop since June.
The broad market index ended trading in the green zone on Monday, rising by almost 0.7% to 3,899.89 points. However, on Tuesday, the S&P 500 returned to negative territory, dropping by about 1% to 3,855.93 points.
"Historically stable falls usually end (or stop) with the onset of a number of days with positive dynamics. At the moment, the rally looks more like a countertrend, while bouts of weakness are a trend," Charles Schwab reported.
In the week since the announcement of the release of August inflation in the United States, the S&P 500 index has lost about 2%.
This report indicated to investors that the Fed cannot slow down the rate hike cycle yet.
On the contrary, the central bank reinforced expectations of another 75 basis point rate hike, accompanying it with formulations implying that it will remain firmly committed to lowering prices.
For currency markets, and for all financial assets, the next important moment will come when the Fed finally turns around and signals the end of the rate hike cycle is approaching. Until then, we can expect that the recent trends of dollar strengthening and stock market decline will remain unchanged, according to ING analysts.
"Since the link between the dynamics of short-term rates and most of the G10 currency pairs has weakened recently, it is expected that most of the market reaction will be due to the reaction of global stocks - here the Fed's still hawkish tone may not be perceived as good news, and this is another reason why we expect a safe dollar will continue to be in demand," they noted.
The two-day FOMC meeting is taking place in an environment of strengthening of the dollar. Yesterday, the greenback rose by 0.6%, finishing around 109.90 points. Meanwhile, the EUR/USD pair plunged by 0.56% to 0.9970.
On Wednesday, the greenback maintained the positive momentum of the previous day and came close to the level of 111. At the same time, the euro continued to slide down, testing the strength of the support at $ 0.9900.
"The next level, which, according to our forecasts, the USD index will reach in the near future, will be 112 points," Commonwealth Bank of Australia analysts said.
"If we just get 75 basis points from the Fed, it will take a pretty hawkish message to push the dollar to this level," they added.
Another bullish dollar momentum from the Fed will mean that the EUR/USD pair will update its multi-year lows, ING strategists believe.
"Today's hawkish message from the Fed will support the initial rates, which, along with the strongly inverted yield curve of the treasury, should provide a good USD boost. The lows of the beginning of September in the area of 0.9870 can be tested in EUR/USD after the announcement of the FOMC decision. A break below these levels will open the door for the pair to decline to the support of 0.9800," they said.
Since the Fed is likely to take decisive action later today, it is possible that the path to a new low in the EUR/USD pair has already been paved, Societe Generale analysts say.
"We forecast a third consecutive increase in the federal funds rate by 75 bps today, but an unexpected increase in the basic consumer price index last week means that an increase by 100 bps is not excluded. We believe that the federal funds rate will be around 4.125% for some time, and a reduction in the rate most likely, it will be postponed until 2024. A more aggressive profile should theoretically lead to an increase in the unemployment rate. Painful trading, if it materializes, will probably consist in a fall in stocks, a further inversion of the treasuries curve and a strengthening of the dollar," they noted.
Given the somewhat limited scope for surprises regarding the size of the Fed's rate hike today, all attention will be focused on the updated forecasts of the central bank, especially on point estimates, according to ING economists.
They expect another upward revision of the median dot graph, as a result of which the final federal funds rate should be 4.25-4.50% in 2023.
A forecast close to 5% at the end of next year would be perceived by the market as significantly hawkish, which would lead to a rise in the dollar. A more modest level of 4.50% would allow us to get the result "buy rumors, sell facts", which would provoke a decrease in the greenback.
At the same time, the central bank's forecasts regarding the cost of borrowing at the end of this year are also important.
Estimates below 4.4% will be negative for the dollar, while forecasts exceeding 4.4% will mean that the Fed is going to raise the rate by 75 bps for the fourth consecutive time in November. This would aggravate the negative sentiment in the markets and would serve as a "fuel" for the growth of the USD.
However, the reaction to the dot chart may later be erased in response to the remarks of Fed Chairman Jerome Powell.
The tone of his statements will determine whether this will be interpreted as the next hawkish move with more of the same ahead, or as the final stage of a rate hike.
"Having little evidence that inflationary pressure is weakening, the head of the Federal Reserve J. Powell is likely to re-emphasize the central bank's commitment to do everything necessary to achieve the inflation target, even if it means the risk of recession," Deutsche Bank strategists said.
If the Fed chairman demonstrates the indisputable attitude of the US central bank to further tighten financial conditions, this can trigger a sell-off in the US stock market, like the one observed in March 2020.
That is, the S&P 500 index risks losing 7-12% from the current levels, which is equivalent to a decline to 3600-3400.
In this case, the greenback will rush up and will not encounter significant technical obstacles up to the 120 mark. In such a scenario, the EUR/USD pair will drop to 0.9000.
On the other hand, if Powell makes it clear that the tightening of monetary policy will end this year, investors will breathe a sigh of relief. This will manifest itself in the sale of the dollar and the rebound of US stocks and the euro from local lows.
However, the breakdown of the downward trend for the US stock market can only occur if the S&P 500 index returns confidently above 4150. Meanwhile, the bullish trend in USD will be called into question only if the greenback leaves below the 50-day moving average at 107.60.
As for the EUR/USD pair, there is reason to believe that the so-called "investment rally" may be short-lived, since geopolitical risks will come to the fore after the Fed meeting.
On Wednesday, Russian President Vladimir Putin announced a partial military mobilization in the country and warned the West that if it continues what the Russian leader called "nuclear blackmail", Moscow will respond with the power of its entire huge arsenal.
This development caused a flight from risks and led to a weakening of the single currency against the dollar.
The greenback had already looked pretty strong before, and the proximity of European countries to Ukraine makes investors think about what the situation might look like if the military conflict between Kiev and Moscow escalates into something more.
"Given that there is no diplomatic solution to the conflict in Ukraine, as well as the deterioration of fundamental indicators for the eurozone, we expect that the EUR/USD pair will soon break through the low of this month in the area of 0.9865, and we maintain our medium-term goal at the low of June 2002 in the area of 0.9305," Brown Brothers Harriman analysts noted
