25.01.202223:32 Forex Analysis & Reviews: Fed meeting: Three main questions that determine the dollar's reaction

Speculators began to return to the dollar, which made a breakthrough, aiming for annual highs. Dollar bulls managed to push it above the 95.30 mark, around which it was stuck last week. The bullish trend has been restored. The nearest resistance is the 96.46 level. Next, bulls will attack the 96.93 level.

Curiously, in parallel with the dollar's growth on Monday, a drop in the yield of 10-year bonds was noted. This is probably due to the fact that the markets are laying the excessive and belated reaction of the central bank to the inflationary surge. Economic growth is under threat, and inflation may slow down in the long run.

The yield of treasuries went up again on Tuesday, and the lack of risk appetite on world markets also continues to support the dollar.

Federal Reserve Meeting

As for the FOMC meeting, market players will be most interested in the announced role of the asset balance in policy normalization. If the focus goes to QT, the forecast of four rate hikes this year may be adjusted. In expectations of tightening policy, there will be a pullback, and the dollar will lose support.

In general, according to analysts, one should not hope for any fireworks or innovations from the Fed's leadership at the January meeting.

"Perhaps the central bank will prefer to go for an early curtailment of the QE program, but even if they do, the impact of the step on the yield of treasuries may be quite limited, given that the markets have already fully included in the prices of the Fed's rate hike in March, and government bond quotes have already closed the bulk of the gap that persisted at the end of 2021. This may limit the potential for tactical strengthening of the dollar against low-yielders, even taking into account the hawkish results of the meeting," JP Morgan writes.

If the Fed raises the rate in January...

At a hearing of the banking committee on January 11, Fed Chairman Jerome Powell announced a clear sequence of actions in normalizing policy. Since the Fed does not like to make surprises in this direction, especially if we are talking about the first increase in the cycle, there is no hope of tightening policy on Wednesday. The probability of such an event is estimated at only 5%. At the same time, the probability of its increase by 0.25% at the meeting on March 16 is almost 95%.

From the meeting, market players are waiting for guidance on actions with a bet. Comments on three issues will be important. Firstly, I am interested in how quickly the program will be completed, now March appears in the deadlines. Secondly, the markets need a benchmark for raising the rate for this year, the base scenario provides for four hikes, whereas in some forecasts we are talking about seven hikes. Thirdly, it is important to know whether the central bank plans to reduce its balance of repurchased assets (reverse QE).

Nothing will affect the current decision of the Fed, there was no release of important data before the meeting and it is not planned to radically change the central bank's position. The report on the labor market and inflation will be presented on February 4 and 10, respectively. There will be no meetings on the monetary policy in February, and in March, if inflation significantly exceeds the forecast, it will be possible to hope for an increase of 0.50 pp at once. At the moment, such a turn of events looks unlikely, but some investors and experts have already begun to focus on this topic.

The Fed needs to act faster, otherwise it risks losing the confidence of the markets. If the central bank's management does not provide the markets with any new information and does not give clearer hawkish signals, the EUR/USD pair may grow.

Hints of a 0.50 pp rate hike in March, a quick QE completion and other hawkish things will trigger demand for the dollar. Crossing the area below 1.1270 would increase bearish pressure.

Support is at 1.1250, 1.1230, 1.1200 (psychological level). Resistance is located at 1.1300 (psychological level), 1.1330, 1.1350.