The Fed will likely yield to the hawkish market expectations and hike interest rate by 75 bp today. Nevertheless, even with such an aggressive move, it cannot be ruled out that the dollar will go into decline following the meeting. Why? Since last Friday, when the May CPI was released, the dollar index has strengthened by a significant 2.4%, setting a new local extreme (105+). Such a move has likely already priced in a 75bp increase in the federal funds rate, so without additional surprises related to the pace of the timeframe of QT or a sharp revision in Dot Plot, a FOMC meeting broadly in line with expectations could become a profit taking signal. In other words, the classic “sell on the facts” scenario can be executed in the dollar market.Asset prices on the market, as well as expectations for the June meeting of the Fed, have changed significantly over the past week. Futures on the Fed rate have completely priced out an outcome where the Fed hikes rate by 50bp. This was supported by inflation data for May and inflation expectations from U. Michigan: headline inflation rose from 8.3% to 8.6% and 5-year inflation expectations of households jumped from 3% to 3.3%. Media reports, that the Fed policymakers were seriously discussing the possibility of raising rate by 75 bp, did their job as the market regarded them as an attempt by the Fed to prepare the markets for such a move during the blackout period – the week leading up to the meeting, when Fed officials are not allowed to make policy statements. In terms of market dynamics, key U.S. stock market indices are down nearly 9% and there is a chance the Fed may try to choose a softer path to limit correction or even boost stock market gains so that the welfare effect smooth out the negative impact of inflation on consumption propensity.The upcoming Fed meeting is especially important because it will feature an updated Dot Plot – a chart showing the distribution of FOMC participants’ assessments of where the interest rate should be in the short, medium and long term. The latest Dot Plot was published in March and looked like this:It’s been three months since then and inflation hasn’t gone down, so markets now expect the Fed’s rate to be in the 3.5-3.75% range by the end of the year. The Fed will most likely move the median forecast to this range, but officials’ expectations regarding the rate next year and 2024 will become more important for the market. If at least a few officials are in favor of raising the rate to 4% and above, then most likely we will see a new rally in DXY to 105.50 or even higher, as expectations for tightening from other major central banks are much more modest.US retail sales data for May came with a big downside surprise today pointing to increased risks of stagflation for the US economy:It is interesting that the negative reaction of the dollar to the report did not last long, as a weak consumption report could increase the chances that the Fed will fight hard against the main negative factor – high inflation and aggressively raise the rate today:
Source: Tickmill
