The EUR/USD is slowly sliding down but stays within the 8th-figure range waiting for this week's main event. On February 1, we'll find out the results of the first Federal Reserve meeting this year.
A landmark event
This is a truly significant event – and not only because the market is actively discussing the further pace and scale of the Fed's monetary policy tightening. As part of the annual rotation of votes, four members of the US central bank will lose the right to vote, and the same number of their colleagues will replace them in this. Including the recently appointed head of the Federal Reserve Bank of Chicago, Austan Goolsbee. According to some estimates, the new composition of the voting members of the Fed will have a more dovish (moderate) bias, given the previous statements of Patrick Harker, Laurie Logan and Goolsbee. Another Fed official who will get the right to vote in 2023, Neel Kashkari, takes a more hawkish position. But he also said in early January that recently there has been more and more evidence that inflation may have "reached its peak."
Formal outcomes and discussions about the future
By and large, the formal results of the February meeting are a foregone conclusion. The probability of a 25-point rate hike is now 99.1% (according to the CME FedWatch Tool). Therefore, the very fact of the implementation of the 25-point scenario is unlikely to surprise investors – this fact was played back a few weeks ago, when the December consumer price index in the United States was published. Most likely, the market will ignore the formal results, focusing on the rhetoric of the accompanying statement and, most importantly, the stance of Fed Chairman Jerome Powell.
To date, traders are concerned about several issues. Among them is the main question: does the Fed intend to revise downwards the final point of the current cycle of monetary tightening? Recent macro data are pushing market participants to a positive response.
Dovish expectations
The flywheel of dovish expectations was launched in early January, when the December Nonfarm report was published. A fairly clear trend has been identified: amid a decrease in unemployment, the growth rates of the number of jobs are slowing down smoothly (for example, the December figures came out in the green zone, but reflected a decrease), while the growth rates of wages are steadily declining. The labor market remains strong, while the salary component gradually but consistently dissipates.
The structure of reports on the growth of the manufacturing ISM and services ISM indicates similar trends: for example, none of the six main manufacturing industries reported an increase in prices in December.
Key inflation indicators also show a steady trend towards a slowdown. The consumer price index came out in the red zone (and both the general and core index), as well as the producer price index. The picture was supplemented by the base PCE index, which has been declining for the third month in a row.
At the same time, the American economy grew by 2.9% in the 4th quarter of 2022, exceeding estimates. However, according to the forecasts of economists of the Federal Reserve of Atlanta, in the first quarter of 2023, the volume of US GDP may grow by only 0.7%.
All this suggests that, first of all, the Fed will definitely move to more moderate steps in the context of rate hikes, and secondly, it will allow the option of revising the peak value of the rate downward (at the moment, let me remind you, the central bank has declared the rate to 5.1%). In this context, the Fed may declare that decisions on rate hikes will be made at each specific meeting, depending on the incoming data.
And if the slowdown in the pace of monetary tightening to 25 points has already been won back by the market, then any hints of an early end of the current cycle will put severe pressure on the dollar.
At the same time, in my opinion, the Fed will rule out the scenario of a rate cut in the second half of the year, even if inflation continues to slow down, and other macroeconomic indicators will show negative dynamics. This position has been repeatedly voiced by Powell and many of his colleagues, even from the representatives of the "hawk wing".
Conclusions
In general, given the preceding rhetoric of the Fed chief, we can assume that the outcome of the February meeting will have a more "dovish bias," with many "buts" and "ifs. There will be no trace of the former aggressiveness in the rhetoric - the focus will be rather on the growing risks of recession in 2023. My guess is that Fed officials will no longer categorically deny the possibility of a pause in rate hikes for the foreseeable future (as they did in the 2022 meetings).
If these assumptions become reality, bulls have a chance to return to the area of the 9th figure by testing the resistance level of 1.0960 (the top line of the indicator Bollinger Bands on the D1 chart). However, until the announcement of the results of the February FOMC meeting, it would be best to stay out of the market, given the high degree of uncertainty.
