USD eases off ahead of tomorrow's FOMC decision

September 19, 2017 09:38 AM

Traders cautious with interest rate decision in mind; the British pound/U.S. dollar (GBP/USD) currency pair's gains after Carney comments; the euro/U.S. dollar (EUR/USD) currency pair pushes 1.20 as eurozone economic sentiment improves.

It’s been a relatively slow start to trading on Tuesday, with traders appearing to be in wait and see mode as the Federal Reserve begins its two-day meeting.

While we’re not expecting any surprises out of the meeting – in terms of another rate hike for example – we should learn a lot about how the Fed plans to tighten monetary policy going forward and that will determine how U.S. yields and the dollar respond. The next phase of tightening is likely to combine rate hikes with balance sheet reduction, with the latter likely being announced tomorrow.

With inflation having not picked up as expected though, the language from policymakers in recent months has become less hawkish and in some cases, quite dovish. With support for a rate hike in December appearing to deteriorate, traders will be keen to learn what we can now expect in the year ahead, both in terms of interest rates but also balance sheet reduction. With so much unknown at this stage, it’s not surprising why traders are cautious, especially as we’re yet to see any real response to the Fed’s plans to cut is trim its almost $4.5 trillion balance sheet.

With geopolitical risk appearing to fade a little and markets becoming a little numb to the ongoing tit for tat between the U.S. and North Korea, central banks are finding themselves back in the spotlight at the moment and it’s not just the Fed that’s attracting attention. Recent commentary from the Bank of England and its Governor Mark Carney has sent the pound back to levels not seen since Monday after the Brexit vote last year, against the dollar.

The pound came off a little yesterday, having traded above 1.36 at one stage after Carney suggested any tightening will be limited and gradual. With markets pricing in a higher chance of a rate hike at the next meeting than not, and fully pricing one in by February, I wonder how much higher sterling can push as it’s unlikely that the BoE will engage in the kind of tightening that we’ve seen from the Bank of Canada, for example. There’s already a clear reluctance to raise at all due to the uncertain backdrop that Brexit offers.

Economic sentiment in both the eurozone and Germany improved significantly last month, providing another lift for the euro which is once again closing in on 1.20 against the dollar. With the pair having failed to hold onto previous moves above here, it will be interesting to see whether traders bail once again or manage to push on through. With 1.1830 offering support below, we may remain range-bound through with dollar traders already having one eye on tomorrow’s Fed decision.

About the Author

Craig Erlam is senior market analyst at OANDA who also writes for OANDA’s Market Pulse site, Marketpulse.com.