Swift USD Rebound After the Fed Spells Trouble for EURUSD Bears


The Fed preferred moderate pace of tightening at the last meeting which contributed to the “sell the facts” market response to the meeting outcome. The Fed hiked interest rate by 50 bp and acknowledged that it will deliver more this year. Given persistence of some pro-inflationary factors (commodity and food inflation, supply disruptions, labor market shortages), the Fed rate may well be above 3% by the end of the year.Powell began his communique by admitting that inflation is too high and that households should know that the Fed knows how painful it is. The unexpectedly clear acknowledgement that inflation had gone too far was at first interpreted as a signal that the Fed would step up the pace of tightening and we would already see a 75bp hike in July, but Powell soon assured that something more than 50 bp not seriously discussed. Markets ruled out a worse outcome, and this was reflected in the corresponding reaction of major asset classes: the dollar went into a correction, risk assets made an impressive rebound (SPX closed with 3% gain), money markets lowered their terminal rate forecast (the rate level at which the Fed will end the tightening cycle).The unequivocal hint that the rate will continue to rise, in fact, stated the fact that the main drivers of “transitory” inflation – commodity prices or disruptions in supply chains are no longer considered as the primary ones, but instead the focus shifts on severe shortage in the labor market and sharply increased pricing power of firms. One the best proxies of labor market tightness which spells the trouble for Fed in terms of persistence of inflation pressures is the number of open vacancies which hit new high in April:There were also the first details on the sale of assets from the balance sheet. According to the statement, the runoff will begin in June, with an initial pace of $47.5 billion and will almost double by September. The consensus forecast assumed an initial pace of $50 billion per month, so there are no surprises here.The baseline scenario for further tightening that the market is pricing in includes one 50bp rate hike in July followed by three more 25bp rate hikes.Greenback correction proved to be short-lived as the currency erased post-FOMC loss on Thursday, the dollar index trades above 103 points gaining 0.8%. This behavior of the dollar near the multi-year high suggests that the current rally is most likely not over yet. The NFP report is ahead, and as the Fed signaled that employment dynamics will be one of the key determinants of monetary policy in the near future, the April labor market report takes on a special significance in shaping market expectations, so the reaction to the release is likely to be strong.Considering the EURUSD pair, a strong Payrolls report will most likely lead to a break below 1.05, where the 2017 low (1.04) may be the target for sellers:Next week the pressure on the pair will likely ease barring new dovish catalysts from the oil market, helping pair to rebound towards 1.06 level.

Source: Tickmill

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