Market alert: what to expect from the Fed?

After a nervous May global markets moved sharply higher in anticipation that central banks will once again bail investors from troubles. These hopes were fueled by the ECB president and now investors expect actions from the Fed. Will it deliver and what does that mean for key markets like Gold, US500 and EURUSD?

Summary:

  • Fed under enormous pressure to cut rates
  • US economy does not warrant monetary easing
  • Gold, US500, EURUSD to be heavily impacted by the FOMC decision

Will the Fed remain calm?

Despite the latest NFP report coming below expectations the unemployment rate in the US is at the multi-decade low, GDP growth was above 3% in Q1, inflation is close to 2% and US stocks are close to all-time highs. At the same markets are pricing 4 interest rate cuts until the end of next year – the first cut expected in July! Why would the Fed bend to these expectations? The main reason is pressure: political pressure from Donald Trump who is seeking reelection and markets pressure as the Fed may worry that declining equity prices could add to global headwinds like trade and geopolitical uncertainties. In this context the Fed could be open to future policy moves but may fall short of reassuring markets that a series of rate cuts (or the July cut) is in the making. Remember, president Powell was very optimistic in May and while he can be somewhat more dovish, aggressive market expectations might be hard to be met.

Before the Fed started the tightening cycle in December 2015 the Committee clearly suggested it at the preceding meeting. A repeat of such suggestion would be the clearest sign of a rate cut in July. Source: federalreserve.gov, XTB Research

These things would be seen as dovish, especially if they appear in combination: removal of “patient” phrase from the statement, pointing at the July meeting as “live” on rates, prematurely ending balance sheet reduction (now scheduled until the end of September), significantly lowering interest rate projections in the dot-plot.  

Markets to watch:

Gold

Gold prices have been rallying in anticipation of policy easing so the FOMC decision and guidance will have a big impact. Unless markets are convinced that Fed is ready to cut interest rates in the near future, further short term rally could be hard to justify. Gold has traded within a very broad consolidation for 3 years and it currently just below the resistance zone of $1360. The key support zone is at $1275.

Source: xStation5

US500

US500 has already recovered 80% of the losses from the previous month, mostly on the back of expectations for the easier monetary policy. Having said this, it’s obvious what stocks want from the Fed. Failure to deliver on markets expectations would be disappointing for stock market bulls and the US500 sees the first support line at 2870 points. Resistance line is located exactly at the all-time high of 2960 points. 

Source: xStation5

EURUSD

EURUSD reversed lower after Mario Draghi suggested monetary easing on Tuesday. This could be a serious game-changer for the currency pair that at least for a moment looked like it was headed higher. It’s out of a downward wedge but the initial rally has faded leaving the decisive move for the Fed. A support at 1.1112 is now closer than a resistance of 1.1346.

Source: xStation5

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