Towards the end of Wednesday's U.S. session, the Federal Reserve will announce the results of its June meeting. The major dollar pairs are frozen in anticipation of the verdict, which will determine the fate of the greenback, at least in the medium term. The June meeting is by no means a mere formality. Any decision, even the most anticipated one, will provoke increased volatility among the major currency pairs. The EUR/USD pair, naturally, will not be an exception.
Notably, there is no consensus in the market regarding the possible outcomes of the June meeting of the Federal Reserve members. On the one hand, traders are confident that the regulator will maintain the status quo today. On the other hand, the future prospects of monetary policy tightening remain unclear. Let's consider the main probable/improbable scenarios of the June Federal Reserve meeting.
Scenario #1. Maintaining the status quo and the "open door" policy
As mentioned above, the market has no doubt that the American regulator will leave all parameters of the monetary policy unchanged today and will hit the brakes for the first time since March last year. And if, until yesterday, some traders still nurtured certain hopes for a hawkish outcome (the probability of a rate hike was around 25%–30%), the inflation growth report published on Tuesday ended those expectations. The May consumer price index reflected a slowdown in inflation in the United States, both in general (to a greater extent) and core (to a lesser extent, but now we can talk about a downward trend).
Immediately after the release, the probability of maintaining the status quo at the June meeting increased to 100%, according to the CME FedWatch Tool. Today, the market has "reconsidered" and still left minimal chances for the implementation of the 25% scenario (the probability is 5%).
Why the market is still not 100% confident—we will discuss this shortly. Here, we will rely on the base scenario, assuming the rate will remain at the same level. Given the general confidence in the realization of this scenario, traders may either ignore or minimally react to the fact of the wait-and-see position, focusing their attention on the future prospects of tightening the monetary policy.
The considered scenario assumes keeping the rate at the same level but with the additional "option" of a possible increase at one of the subsequent meetings—in July or September. The clearer the corresponding hint is, the stronger the reaction of the dollar bulls will be.
According to most experts' assessments, this is the most likely scenario. That is why long positions on the EUR/USD pair are currently very risky. After yesterday's inflation release, buyers of the pair, in my opinion, prematurely started celebrating victory. The fact of inflation slowdown only maximized the probability of maintaining the status quo in June but nothing more. The Federal Reserve will likely "stay put" this month but allow for a rate hike in the future if inflation accelerates again or the pace of inflation decline slows down.
Additionally, the regulator may rule out the possibility of a rate cut this year, thus debunking the corresponding rumors. In that case, the dot plot will be in favor of the greenback, indicating another rate hike by the end of the current year.
The realization of this scenario will depend on the dynamics of inflation growth in June–July. The growth/reduction of key inflation indicators will determine the degree of hawkishness of the Federal Reserve going forward. However, in the immediate moment, this scenario will provide support to the American currency since, de facto, the Federal Reserve will hit the pause button rather than the "stop" button.
Scenario #2. Maintaining the status quo without hawkish hints
The second scenario entails keeping the interest rate at the current level without additional hints about its increase in the foreseeable future. Let's be clear—this is an unlikely but still quite possible development. The Federal Reserve may focus on the side effects of aggressive policies: a banking crisis, rising unemployment (recall that the unemployment rate has been rising for the second consecutive month), dismal ISM indices, deteriorating company forecasts, and the threat of a recession. In this context, the Federal Reserve may effectively announce the end of the current cycle of monetary policy tightening, presenting a potential rate hike in the future as an extraordinary event.
In such a case, the greenback will come under strong pressure since, according to the aforementioned CME FedWatch Tool, the probability of a 25-basis-point rate hike after the July meeting stands at 62% (assuming the status quo is maintained in June). If the Fed's rhetoric today carries a "conclusive" character, this probability will noticeably decrease.
Scenario #3. Hawkish surprise
It is important to note that the "hawkish scenario" is the least probable among all possible scenarios. However, it cannot be completely ruled out. Recall that before the onset of the so-called "quiet period," some representatives of the Federal Reserve voiced hawkish signals, calling for further tightening of monetary policy.
For example, Federal Reserve Bank of Cleveland President Loretta Mester stated that there are currently no compelling reasons for a pause in rate hikes. Former Dallas Fed President Robert Kaplan supported his colleague, noting that the incoming data "supports a rate hike at the next meeting." Doubts about a possible pause were voiced by Thomas Barkin, Raphael Bostic, and John Williams. Representatives of the hawkish wing of the Federal Reserve primarily pointed to the core PCE index, which entered the "green zone" at the end of May. From September to December last year, this important inflation indicator consistently declined (from 5.2% to 4.6%). Then, in January and February, it stood at 4.7%, and in March, it returned to the December level of 4.6%. However, in April, the index once again reached 4.7%, despite a forecasted decline to 4.5%.
It is worth noting that the "hawkish" scenario is currently indeed unlikely—according to the CME FedWatch Tool, the probability of its implementation is only 5%. However, it cannot be completely and absolutely ruled out, considering the position of some representatives of the Federal Reserve.
Conclusions
Most currency market experts are confident that the Federal Reserve will maintain the status quo today but will indicate that the central bank is still ready to resume rate hikes at future meetings if incoming economic data suggests stable inflation and a tight labor market situation. Such an outcome will support the greenback despite the actual pause—the first since March last year.
In addition, scenario #2 (maintaining the status quo + no clear hints of rate hikes in the foreseeable future) is also quite probable, given Jerome Powell's cautious stance (which he voiced in May) and the decline in the consumer price index.
In the face of such uncertainty in the EUR/USD pair, it is advisable to maintain a wait-and-see position.
