Despite the Fed’s updated dot plot last week signaling that two more rate hikes may be on the cards, market participants are finding it hard to believe it. Fed Chair Powell did not convince them either when he held the press conference following the decision. However, he is being given another opportunity to pass his message this week as he is testifying before Congress on Wednesday and Thursday at 14:00 GMT.
Investors don’t believe the Fed
At last week’s meeting, the Fed decided to hit the pause button, skipping a hike for the first time since March 2022. However, it was more than clear that this was not the end of the tightening crusade, rather than a small break to evaluate incoming data and how prior increases may have affected the world’s largest economy. After all, the updated ‘dot plot’ pointed to 50bps worth of additional rate hikes later this year before the end credits roll.
Having said that though, market participants remained unconvinced that this could be the case, continuing to price in only one more quarter-point hike and a series of rate cuts through next year, despite Fed Chair Powell saying at the press conference that any rate cuts are “a couple of years out.”
Powell gets a second chance to pass the message
This week, Chair Powell will have another opportunity to convince the financial community about the Committee’s intentions, on Wednesday and Thursday, when he is testifying before Congress. With the PMIs suggesting easing price pressures, the CPI slowing faster than expected, and wage growth softening as well, it may be hard for the Fed Chief to find convincing arguments regarding the need for two additional rate hikes. After all, the full effect of the prior increases is not fully felt by the economy yet.
A relatively reasonable argument may be that, despite also sliding notably, inflation expectations suggest that in a year’s time, inflation will still be above the Fed’s 2% target. The University of Michigan is calculating a 3.3% y/y rate for next June, while the New York Fed model is pointing to a higher 3.76% rate. So, taking these rates as a given, it may be unwise for the Fed to start cutting rates massively next year.
Dollar could gain, but bullish reversal still premature
So, if Powell highlights the need for higher-for-longer rates because there is still a long way to go before the job is done, the dollar could gain and equities could correct lower. Nevertheless, with inflation expectations not being an accurate forecasting tool, but rather a comparison tool and a moving untouchable target, calling for a bullish trend in the dollar would still be premature.
Incoming data pointing to further cooling of price pressures could translate into further declines in inflation expectations and perhaps allow market participants to maintain their rate-cut bets for early next year. Currently, conditional upon a July or September hike, they even see more than 50bps worth of reductions by next May.
With the BoE expected to deliver 140bps worth of additional rate hikes, Fed cut bets are likely to keep pound/dollar in an uptrend for a while longer, especially if UK policymakers adopt a more aggressive stance when they meet on Thursday.
Pound/dollar uptrend may be destined to continue
Just last Thursday, Cable emerged above the 1.2670 barrier, which offered resistance on May 10 this year and back on May 27, 2022, confirming a higher high on the daily chart and signaling the continuation of the prevailing medium-term uptrend.
The pair is currently in a sliding mode, but even if it continues for a while longer due to Powell appearing in his hawkish suit, the bulls could recharge from above the key 1.2340 zone and push the pair up again. A potential catalyst for the rebound may be a hawkish BoE on Thursday. The rebound could take the price back above 1.2670 and perhaps aim for the 1.2975 zone, which acted as key support between March and April 2022.
Now, if pound/dollar falls below 1.2340, it will enter its flat zone and thus, the outlook may be considered neutral. For the picture to turn bearish, a break below 1.1795 may be required. Such a dip could initially target the 1.1650 level, the break of which could see scope for declines towards the low of November 9 at 1.1335.
