The USD has rallied this week can it continue its rally next week? The key event of the week will be the Fed meeting which is expected to trigger volatility in USD pairs. Our view of FOMC and the likely reaction in the markets is summarized below...
The chart below comes from INGTHINK and gives their views on the Fed and likely market reactions to various scenarios.
We agree with ING's base case scenario but think the Fed will emphasize that there are going to be no rate cuts shortly even as the inflation eases – the market is already seeing cuts early in 2024 and the Fed will want to push back against this view. The views of GS and a couple of charts below which we agree with...
"We expect a hike next week to 5.25-5.5% to be the last of the cycle. But on a probability-weighted basis, our Fed views remain more hawkish than market pricing. This reflects both our lower probability of recession and our expectations that the threshold for rate cuts will be fairly high and that cuts will be gradual" (GOLDDMAN SACHS)
If we look at history it's clear that the Fed will have to keep rates higher for long than the market expects to cool inflation and they won't want to make the mistake of cutting rates too soon.
In terms of the market's view of rates against the DXY...
Market Positioning
With the market positioning itself for a dollar sell-off in the coming months, we expect a hawkish Fed message to push back on quick interest rate cuts. The FX options market, expected EUR/USD 24-hour trading range over both the Fed and European Central Bank decisions next week is only 60 USD pips which is very low. We expect bigger volatility and the USD to rally.