As the U.S. session comes to an end on Wednesday, the Federal Reserve will announce the results of its two-day May meeting. This crucial event is the focus of all dollar pair traders. Depending on the outcome of the May meeting, the greenback will, as they say, either be with a shield or on a shield. The dollar will either weaken its position across the market or re-enter the battle on a wave of hawkish Fed rhetoric.
In the context of the EUR/USD pair, this means that the price will either conquer the 11th figure or return to the 7–8 figure range, reflecting the strengthening of the greenback. An alternative option is also possible, in which the initial reaction of the pair's traders (no matter whether downward or upward) will not develop, after which the price will return to the already familiar range of 1.0960–1.1070, within which the pair has been trading for the second week.
Overall, several possible scenarios can be identified. More precisely, three. Each scenario assumes an interest rate hike of 25 basis points (according to the CME FedWatch Tool data, the probability of a hike is almost 90%). The intrigue lies in the subsequent rhetoric of the Central Bank in light of recent releases and events in the U.S. banking sector.
Scenario #1: Hawks spread their wings
The first scenario involves strengthening hawkish rhetoric from FOMC members (which will be reflected in the accompanying meeting's tone) and directly from Jerome Powell. Having raised the rate by 25 basis points, the regulator may state that tightening monetary policy, firstly, is not excessive, and secondly, is insufficient, considering the dynamics of inflationary growth.
Several arguments support this scenario. First of all, the growth of core inflation. Recall that the core consumer price index, excluding food and energy prices, rose to 5.6% year-on-year. For the preceding five months, the core index consistently declined (from 6.6% to 5.5%). For the first time in the past six months, the core CPI growth rate accelerated.
Also, in favor of strengthening the hawkish mood of the Fed are the inflationary components of the U.S. GDP growth report. The core price deflator in the first quarter was in the "green zone," rising by 4.9% annually (with a forecast growth of 4.7% YoY). Consumer spending jumped by 3.7% (the highest growth rate since the second quarter of 2021).
The implementation of the hawkish scenario will open the way for EUR/USD bears to the 8th figure area. After the support level of 1.0960 (the middle line of the Bollinger Bands indicator on D1), the next most significant price barrier will be the 1.0870 mark – the lower line of the Bollinger Bands on the same timeframe.
Scenario #2. Moderate "hawkishness"
It should be noted right away that this scenario is currently the baseline. According to this scenario, the Fed increases the rate by 25 basis points, acknowledges the slow pace of inflation decline, and leaves the door open for further tightening monetary policy. However, the Federal Reserve implies that the next possible increase will only be in case of intensifying inflationary pressure ("if such a need arises in the future").
In my opinion, this scenario looks most realistic, considering the current fundamental background. On the one hand, inflation is decreasing slowly, and some components even show an upward trend, as mentioned above. But on the other hand, the Federal Reserve has to take into account the side effects of aggressive policy. Among the obvious manifestations of these side effects are weak growth in the American economy and the risk of recession. Recall that according to the latest data, the U.S. GDP increased by only 1.1% in the first quarter, while most experts expected a 2% growth in the indicator. The downward trend is observed for the second quarter in a row.
In addition, we cannot forget about the "spring bank collapse" that shook the U.S. banking system. First Republic Bank became the third major American bank to go bankrupt in the last two months after Silicon Valley and Signature. This series of bankruptcies occurred amid the Federal Reserve's tightening monetary policy. For example, due to the increase in the discount rate last year, First Republic's mortgage portfolio, valued at $138 billion at the beginning of the year, fell by $19 billion.
There are other fundamental factors suggesting that the Federal Reserve will not take drastic actions. In particular, the ISM manufacturing index has been below the key 50-point mark for the sixth month in a row, exceeding which reflects an improvement in the manufacturing sector (the indicator stood at 47.1 points in April). The number of building permits issued in the U.S. has sharply decreased by 8.8%. The gloomy picture was completed by the volume of housing sales in the secondary market—in March, it decreased by 2.4% (the weakest result since November 2022). Retail sales were also disappointing. In March, sales volume in the States decreased by 1% in monthly terms, following a 0.2% decline in February (most experts expected a more modest drop in the indicator—by 0.4%). Retail sales excluding automobiles decreased by 0.8%, with a forecasted decline of 0.3%.
Inflation indicator Nonfarm Payrolls report also turned out to be in the "red zone": average hourly earnings increased by 4.2%, with a forecast of 4.4%, the weakest growth rate of the indicator since August 2021.
In the case of the implementation of the base scenario, the EUR/USD pair will demonstrate high volatility, but in the end, most likely, it will remain within the price range of 1.0960–1.1070, waiting for the May meeting of the ECB (which will take place tomorrow, May 4).
Scenario #3: Dove's song
According to the conditional "dovish" scenario, the Federal Reserve will raise the rate by 25 basis points but will focus on the risks of further tightening of monetary policy. The arguments in favor of this version are listed above (weak U.S. GDP growth, bankruptcy of three large banks, decline in many macroeconomic indicators).
If the Federal Reserve actually implies that the May increase will be the last one this year, the dollar will come under significant pressure. In this case, buyers of the EUR/USD pair will be able to overcome the resistance level of 1.1060 (the upper Bollinger Bands line on the daily chart) and try to consolidate in the area of the 11th figure.
Conclusions
In my opinion, the combination of fundamental factors suggests the implementation of the base scenario, which implies a "moderate hawkishness" of the Federal Reserve. In this case, EUR/USD traders are highly likely to be unable to determine the price movement vector, especially since the European Central Bank's decision will be looming on the horizon, with its verdict coming on May 4.
Considering such a high degree of uncertainty, it is advisable to take a wait-and-see position on the EUR/USD pair, as false impulsive price movements may occur within the next 24 hours. In such turbulent conditions, it is safest to stay out of the market.
