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02.02.202306:40 Forex Analysis & Reviews: EUR/USD. The Fed has not become the dollar's ally, despite Powell's hawkish attitude

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The EUR/USD pair, reacting to the outcome of the Federal Reserve's February meeting, tested the resistance level of 1.1000 for the first time since April last year. And although bulls failed to impulsively conquer the 10th figure, the pair remains bullish. The Fed did not become an ally of the US currency, despite the hawkish messages of Fed Chairman Jerome Powell.

The central bank expectedly slowed down

The formal results of the February meeting fully coincided with market expectations. The central bank slowed down the rate hike to 25 points, raising it to 4.75%, the highest since October 2007. Last week, the market estimated the probability of a 25-point scenario at 90% (according to the CME FedWatch Tool). Ahead of the February meeting, this probability increased to 99.5%. In other words, this isn't surprising. If the central bank had made any other decision it would have provoked serious turbulence in the markets, which is unacceptable (and uncharacteristic) for Powell.

Exchange Rates 02.02.2023 analysis

The pair fell to 1.0890 after the announcement of the results of the February meeting. And an hour later the price soared to the limits of the 10th figure, reacting to Powell's stance. Traders were primarily interested in further prospects for tightening monetary policy, and, judging by the pair's reaction, Powell still ended up disappointing the dollar bulls. It is obvious that the Fed is nearing the end of the cycle, and this fact can no longer be overshadowed by verbal "pumping".

What the Fed said

Powell traditionally tried to maintain a balance in his rhetoric. On the one hand, he said that the central bank "has a lot of work to do", thus hinting at a further increase in the interest rate. The central bank also retained the wording that "the Committee will take into account the cumulative tightening of monetary policy,".

On the other hand, Powell said that the Fed recognizes that the pace of inflation has cooled. In this context, he said that the members of the Committee discussed the possibility of raising the rate "a few more times" before the end of the current cycle of monetary tightening. At the same time, Powell says it's 'premature' to declare victory against inflation, after which the process of raising the rate will be resumed. The central bank intends to complete the cycle and put an end to it, after which the Committee will keep the rate at the achieved level for quite some time.

As a result of the meeting, the US dollar index fell to 100.83 (the lowest value since April 2022), ignoring the general hawkish mood of Powell. Dollar bulls were clearly embarrassed by the "final notes" in the rhetoric of the Fed chair. Powell revealed on Wednesday that the central bank is discussing a "couple more" interest rate hikes to reach the point where the monetary policy is sufficiently restrictive to drive inflation down. At the same time, he said that the Bank is very far from this level. Powell acknowledged that the disinflationary process has already started in several sectors, for example, in the housing sector.

Accents have shifted

In the text of the accompanying statement, the "inflationary wording" was also somewhat softened. As a result of previous meetings, the central bank noted imbalances in supply and demand and high energy prices. In the February final communique, the central bank said that the price increase "weakened somewhat", although it is at elevated levels.

One more phrase can be noted, for which, apparently, the bulls got hooked. The Fed said it "will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments" when it comes to determining the way forward. Assessing the pace of future rate hikes, Fed members also noted that they would take into account "a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments".

Exchange Rates 02.02.2023 analysis

Let me remind you that the updated "point forecast" of the Fed will be published following the results of the next - March - meeting. Based on the results of the February meeting, one can make a cautious conclusion that the central bank is preparing the markets for the finalization of the process of tightening monetary policy. The shift in emphasis in rhetoric points to the imminent end of the cycle. If the January and February inflation figures show a downtrend again, there will be rumors that the central bank will limit itself to another - the last - 25-point increase (despite Powell's assurances of several hikes). Such discussions will put pressure on the greenback.

Take note that at the moment, the probability of maintaining the status quo following the results of the March meeting is estimated at 15% (according to the CME FedWatch Tool). This is quite a lot, given the hawkish attitude of the Fed chair.

Findings

The Fed is gradually preparing markets for the finale of the current cycle of monetary tightening. Powell dismissed the most dovish scenarios (pause in rate hikes, rate cuts within 2023), but also made it clear that the Bank is nearing the end, and it's just around the corner. Now the US macroeconomic indicators (primarily inflation) will be viewed by the market through the prism of the most important questions: will the current cycle end in May or still in March? Will the central bank maintain its 25-point pace or will it cut the pace of rate hikes again?

In general, such discussions are not in favor of the dollar, regardless of the probability/likelihood of the options being discussed.

But despite the bullish mood, longs are still risky. One more test for the pair just ahead, and this time it is the test given by the European Central Bank. Results of the ECB's February meeting will either pave the way to the area of 10-11 figures or pull the pair back to the range of 1.0700-1.0850.

Irina Manzenko
Analytical expert of InstaForex
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