US Dollar: How Will Markets Interpret the FOMC Policy Announcement?

The US Dollar is likely to look to the presence of changes in the Fed’s forward guidance as the key consideration in judging the FOMC policy announcement.

Talking Points

US Dollar to Judge FOMC Outcome Based on Change in Forward Guidance
Euro to Extend Gains if CPI Tops Forecasts, Limiting Scope for ECB Easing

Financial markets are likely to look past the European economic calendar as all eyes turn to the outcome of the Federal Reserve monetary policy announcement. Traders will look for confirmation of consensus expectations calling for the central bank to begin “tapering” the size of its monthly asset purchases in September. Officials have just the policy statement to convey their message to the markets this time and so are likely to select language that is as neutral as possible to limit scope for the kind of volatility that was seen after the June sit-down.

With that in mind, the market-moving bit of the announcement is likely to be the presence or absence of changes to the forward guidance component of the Fed’s policy mix. In this context, a dovish scenario will see the FOMC supplement familiar taper-related language with the introduction of a lower bound on inflation and/or a reduction in the threshold for the unemployment rate needed to be achieved before rate hikes enter the picture. That would cement policymakers’ intention to remain accommodative even as tapering commences, weighing on the US Dollar. By contrast, a hawkish outcome would see policymakers abstain from changes to forward guidance, a result likely to boost the greenback.

The flash estimate of July’s Eurozone CPI reading headlines the European docket. Expectations call for the headline year-on-year inflation to remain unchanged at 1.6 percent but yesterday’s upside surprise on the analogous German print opens the door for more of the same on the region-wide metric. The Euro continues to track monetary policy expectations and a pickup in price growth is likely to be supportive in terms of limiting scope for a dovish turn at the ECB when the central bank delivers its policy announcement later in the week. The single currency is already on the upswing following an encouraging set of German unemployment figures.

The second-quarter US GDP report is also on tap, with output expected to grow 1 percent compared with the 1.8 percent increase in the prior period. The release is unlikely to generate a lasting response beyond initial knee-jerk volatility however as the FOMC announcement hogs the spotlight.

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