The US Dollar (USD) is facing its first main event of 2024 with the US Federal Reserve rate decision for January. All eyes will be on the Federal Reserve Chairman Jerome Powell and what he will deliver to the markets. Although no rate changes are expected, the tone of the statement from Powell can still be either hawkish or dovish and could dampen hopes for a quick rate cut further with a repricing for a (stronger) US Dollar at hand.
On the economic front, a perfect menu lies ahead of the main event this Wednesday evening. Traders already had the ADP Employment Change, which was coming in substantially lower than expected. The Chicago Purchasing Managers’ Index for January is due to be released as well, with traders seeking confirmation of the number jumping out of contraction territory (over 50), like the PMI prints last week. Such a move would help confirm a recovery and soft landing.
The US Dollar Index (DXY) might find its catalyst this Wednesday. For nearly two weeks now it has been unable to trade away from both the 55-day (103.02) and the 200-day (103.54) Simple Moving Averages despite several false breaks and both MAs getting all chopped up.
Although the Fed meeting this Wednesday is unlikely to usher in any rate changes, the outcome could still favor the Greenback if Powell delivers a hawkish statement to the markets. Such a move would see market expectations pushback on when the Fed will make its first rate cut.
In such a scenario the DXY will be able to break away from the 200-day SMA. Look for 104.36 as the first resistance level to the upside, in the form of the 100-day SMA. If that gets breached as well, nothing will hold the DXY back from heading to either 105.88 or 107.20 – the high of September.
On the other hand, with the repetition of another break above the 200-day SMA, yet again, a bull trap could also form if prices then start sliding below the same moving average. This would see a long squeeze, with US Dollar bulls being forced to start selling around 103.10 at the 55-day SMA. Once below that, the downturn would be open to 102.00.
Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.
A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.
A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.
Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.