US Dollar: How to Trade the Fed Decision, Speech for Maximum Profitability

Today’s US economic calendar highlights include ADP private payrolls, ISM Manufacturing PMI, JOLTS Job Openings, and of course, the FOMC monetary policy decision. So, the US dollar will be in sharp focus, and how it closes the session could potentially shape its direction for the rest of the week. While Tuesday’s employment cost index pointed to strong wage growth, it is worth pointing out that the data was quite backward-looking as it is a quarterly print. Recent survey-based data have been far from great, in contrast to hard data.

Indeed, Tuesday’s release of Chicago PMI was much weaker at 37.9 vs. 44.9 expected, while a gauge of consumer confidence from the Conference Board also dropped more than expected to 97.0 from a downwardly revised 103.1 the month before. But it was the Employment Cost Index that took all the attention, which came in hotter at 1.2% vs. 1.0% q/q expected.

Apart from the ISM manufacturing PMI, the rest of today’s figures are second-tier in nature and unlikely to cause a significant move in the US dollar. Attention will then turn to the FOMC policy decision later in the day. Thursday is set to be a quieter day for data releases. The ISM services PMI will be released on Friday, following the April non-farm jobs report earlier in that day.

Even before the hawkish repricing of US interest rates in the last few weeks, virtually no one was expecting a rate cut in May. So, the key focus of this meeting will be on how the Fed is assessing the direction of prices and employment. Previously Powell and co had dismissed the hotter inflation data in the first months of the year, but recently the rhetoric has changed, and we have seen a corresponding rally in the US dollar. The market is now expecting a more hawkish-leaning FOMC meeting. But any inclination towards a rate cut before the end of the summer would now provide a dovish surprise.

Inflation has surpassed expectations in recent months and throughout the first quarter, and yesterday’s employment cost index was just the icing on the cake as it confirmed inflationary pressures so far this year. There is therefore little reason for the Fed to consider cutting rates sooner, other than the pressure it may be under from the US Treasury Department. With yields remaining high, this is making it increasingly costly for the government to borrow and make interest payments.

Yields could rise even further, should the Fed provide a more hawkish assessment of inflation than expected. The market is now not pricing in the first rate cut from the Fed until November. For the whole year, only 1 full rate cut is expected, with only 31 basis points worth of cuts penciled in by traders for this year. As a reminder, some 150 bp of cuts had been priced in at the start of the year. A remarkable turnaround.

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But with the market pricing out the prospects of a rate cut before the end of the summer, any hawkish messages from the Fed are unlikely to provide significant further support to the dollar than a dovish surprise might. So, I don’t expect to see a big rally in the US dollar unless the Fed is super hawkish and floats the idea of another rate rise. Instead, the market mw turn its attention to the release of more important data coming up later in the week…

Later in the week, we will have even more significant data to look forward to from the US, with non-farm payrolls and ISM services PMI both due for release on Friday.

Friday’s key macro highlight will be the nonfarm payrolls report. Recent robust growth data and persistently high inflation figures have tempered expectations of rate cuts in 2024. But while hard data has been strong, we have seen soft survey-based figures, pointing to weakness. It is also possible that the extent of hawkish repricing may already be priced in. Therefore, any signs of weakness in US employment or wages data could alleviate concerns about the Fed's capacity to lower rates, leading to a potential sell-off in the dollar and fresh rally in gold.

The ISM services PMI will be released a couple of hours after the NFP data. Last week, the S&P Global PMI data showed US business activity increased at a sharply slower pace in April amid signs of weaker demand. Its services PMI showed the weakest reading in 5 months as orders fell in both the manufacturing and services sectors and companies responded by scaling back employment. If this is anything to go by then the closely watched ISM survey could disappoint expectations and potentially lead to some dovish repricing of Fed interest rates.

As things stand, the trend is bullish on the dollar index as it is holding above the 21- and 200-day moving average. This is suggesting objectively that the trend is bullish on both the short- and long-term horizons.