US DOLLAR, FOMC – TALKING POINTS

US Dollar may gain if Fed rate cut and commentary spooks financial markets

Optimism about cheap credit prospects may be undermined by risk aversion

Commentary from Fed Chairman Jerome Powell will be crucial to monitor

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APAC RECAP

Early into Wednesday’s trading session, APAC equities were all swimming in a sea of red amid concerns about a falling out in US-China trade relations. Talks are currently being held in Shanghai between the USTR and a US delegation with their Chinese counterparts. Early into Wednesday’s trading session, New Zealand confidence data sunk NZD while Chinese PMI came in mixed and Australian CPI beat forecasts.

FOMC MEETING MAY SPOOK MARKETS, PUSH US DOLLAR HIGHER

Investors from all corners of the financial market will be tuning in to the FOMC rate decision and commentary from Fed Chairman Jerome Powell. An overwhelmingly majority of market participants are anticipating a 25 basis-point rate cut and are likely hoping for the subsequent remarks to contain dovish undertones. However, even with a rate cut, the US Dollar may actually gain at the expense of equity markets.

This is counter to what we have frequently witnessed this year. Whenever markets have found excuses to believe the Fed will adopt a dovish monetary outlook either from poor US data or comments from Powell, the S&P 500 gained. This is likely because investors are now heavily relying on the supply of cheap credit boost equity indices because underlying economic growth is too weak to fuel markets by itself.

Therefore, any policy measure or commentary from the Fed that falls short of the market’s dovish benchmark will likely be read as comparatively less dovish – or more hawkish – and may cause equity markets to dip. This would likely be the reflection of investors panicking that the central bank will not throw them the lifeline of cheap credit as they continue to swim into the abyss of riskier assets.

The US Dollar may therefore catch a haven bid if Powell spooks markets and a premium is then placed on liquidity and safety over returns. The redirection of capital to Treasuries and the Greenback could therefore be read as a reflection of where investor priorities are in light of the Fed’s decision and outlook. Tune into DailyFX Chief Strategist John Kicklighter’s live webinar covering the FOMC rate decision!

EUROPEAN DATA MAY AMPLIFY RISK AVERSION

Critical data out of the Eurozone may amplify risk aversion caused by the FOMC rate decision. Italy, the bastion of euroscepticism and fiscal exceptionalism, will be publishing its GDP data with expectations of a 0.1 percent contraction both on a quarter-by-quarter and year-on-year basis. Eurozone GDP and core CPI will also be published which may fuel rate cut bets and reinforce ECB President Mario Draghi’s gloomy comments.

Economic data out of the Eurozone has been tending to underperform relative to economists’ expectations with inflation forecasts showing greater weakness. 5Y5Y Euro inflation forward swaps – typically used to analyze where price growth expectations lie – in June hit its lowest point ever. This is in addition to the Bloomberg Economics Eurozone Uncertainty Gauge clocking in its highest reading since the debt crisis.

CHART OF THE DAY: US DOLLAR INDEX CONTINUES TO RISE DESPITE MOUNTING FED RATE CUT BETS

US Dollar index chart created using TradingView

USD TRADING RESOURCES

--- Written by Dimitri Zabelin, Jr Currency Analyst for DailyFX.com

To contact Dimitri, use the comments section below or @ZabelinDimitrion Twitter