FX Commentary: Powell’s message will determine market appetite for the dollar

Thoughts ahead of Wednesday's big risk event...

We are all awaiting the Fed with as much enthusiasm as any trader or investor out there. However, FX-wise, we believe the dollar is going to clearly sink across the board if Powell clearly rings the bell of monetary loosening. Thus far in 2023, speculation alone that by the second half of the year, the Fed will no longer increase interest rates has caused a 2.0% decline for the buck.

While all will be far clearer on Wednesday post-press conference by Chairman Jerome Powell, most traders expect him to announce whether the terminal interest rate will need to be higher than 5.0%. As it stands, a 50 basis-points increment Wednesday would suffice to reach that target, so plenty of questions will come in trying to figure out how much longer officials plan to hike after.

Anything like a 25-bps increment means that Powell and others see the need to keep increasing rates but at a slower pace to allow themselves the opportunity to wait-and-see and hike if data does not meet what they desire. GDP growth and other indicators could change their minds, and slow hikes may ease market fears of a tight-policy-induced recession while closely keeping inflationary pressures under control and downward.

In the past, Powell has successfully surprised as well as confused markets. Nothing can be taken for granted. Volatility remains high coming into this new year, and it will be hard to appease markets since global steadiness has not been a characteristic for the last three years. If he explains that more of a dent to the economy is what he feels is required to truly hurt price growth and bring the inflationary pace to 2.0%, equity markets will crumble, and thus the buck could recuperate ground.

We believe this scenario is less likely, but one to maintain in mind. An outlook for the short month of February will be out by the end of this week as, hopefully, uncertainty fades.

Juan Perez Senior FX Trader and Strategist Monex USA

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