Fed Says Rates To Be Higher For Longer

The December FOMC outcome yesterday was noteworthy in that, while the Fed finally pivoted on rates, the accompanying guidance was more hawkish than expected. The net outcome was that USD has been well bid on the back of the meeting while risk assets have suffered. The main driver here was the Fed lifting its peak rate projection to 5.1% in 2023 from 4.8% prior. With the Fed signalling higher rates for longer and ruling out rate cuts until 2024 at the earlier, USD bears were left with little to run off. 

What Now For USD?

So, does that mean we can expect USD to take another step higher here and continue the bull trend of most of 2022? Not quite. While yesterday’s outlook from the Fed was disappointing for those looking for a USD sell off, it’s important to note that this is simply the Fed’s base case scenario. As the Fed itself acknowledged yesterday, inflation remains the key aspect and with that in mind any sharp and sudden drops in inflation over the early part of next year might well merit a shift in tone from the Fed.

CPI Still Key 

CPI is now down 2% in the last 6 months; if we see prices cool by a further 2% or more over the coming six months, the Fed might well start to temper its peak rate projections, bringing a pause in tightening forward, which would send USD sharply lower. Consequently, while USD might remain supported into next year, the outlook looks fraught with downside risks.

Technical Views

DXY

The sell off in DXY has seen the market continue to push below the 104.95 level. However, the moves are looking more laboured, framed by a falling wedge pattern and accompanied by bullish momentum divergence, signalling potential for a move higher near-term. To the topside, 109.18 and the bear channel top is the key area to watch with bulls needing to see a break of this zone to put momentum back on their side.