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FOMC Preview: No Rate Cut But 3 Things to Watch

Published 28/04/2020, 20:39
Updated 09/07/2023, 11:31

The U.S. dollar traded sharply lower ahead of Wednesday’s first-quarter GDP report and Federal Reserve monetary policy announcement. Consumer confidence also fell to its weakest level in four years. Between tomorrow’s two big events, GDP should be more market-moving than FOMC because the Fed is not expected to change interest rates. GDP will give us the first look at how badly the U.S. economy was hit by COVID-19 and if the contraction was deeper than expected. There was only two weeks of full lockdown in Q1, so investors will immediately sell U.S. dollars on soft data as they fear that the Q2 numbers will be even worse. A contraction of any size would be the first since 2011, and as long as GDP falls by more than 1%, it will be the biggest decline in 11 years. If GDP growth falls less than expected because the data only incorporated two weeks of economic shutdown, the U.S. dollar could bounce, but the rally will be short-lived as investors downplay the data and turn their focus to the Fed.

After easing aggressively in March, the Federal Reserve is widely expected to leave interest rates unchanged on Wednesday. Its main goal over the past month has been to stabilize a stock market that was swinging by a thousand points a day and to pump liquidity into the financial system. By those measures, it has been very successful, but investors are focused on growth. So for this monetary policy announcement, there are three main questions for the Fed:

1. How long will rates remain low?
2. How deep will the contraction be?
3. What other steps can the Fed take?

Coming off the heels of Q1 GDP, investors will be keen to see what the Fed expects for the economy this year: How deep could the contraction be? How long will the Fed keep rates near zero? And, what other steps could it take? There’s no question that the Fed will reiterate its pledge not to raise rates any time soon. It’ll have to acknowledge that the economy has been hit hard by COVID-19 with second-quarter growth likely to be very weak. The question here is whether Fed Chair Jerome Powell emphasizes the “strong rebound” that will occur when the economy reopens or the grave uncertainty ahead. If he laces his comments with optimism, the dollar could rally. But if he suggests that the new social distancing measures will lead to a slower recovery, USD/JPY could head below 106. Traders should also look at the Fed’s GDP forecast, its pace of asset purchases and any technical adjustments to the rate for excess reserves. It has already been slowing bond buying as market functionality normalized, so it could make it formal.

The commodity currencies extended their gains against the greenback, which was no surprise, considering that Australia and New Zealand are opening up their economies after successfully controlling the coronavirus. Both currencies are in focus tonight with New Zealand trade and Australian inflation data scheduled for release. Inflation expectations increased in Australia in the first quarter, which should lead to relatively stable CPI. If we are right, this should reinforce the rally in the Australian dollar. New Zealand’s trade surplus is also expected to improve, which should fuel further gains for the New Zealand dollar. USD/CAD dropped below 1.40 for the first time in nearly two weeks. Considering that oil prices are lower, this move was driven entirely by U.S. dollar weakness.

The euro, which had come close to 1.09 at the start of the New York session came off earlier highs. We expect the euro to underperform ahead of EZ GDP and ECB. German inflation and Eurozone confidence numbers are scheduled for release tomorrow, with softer data is expected all around. Sterling ended the day up slightly stronger versus the greenback despite weaker CBI distributive trades.

Latest comments

Thanks. So informative this article.
thanks!
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