Derek Halpenny, European Head of GMR at MUFG, notes that the dollar had a bad week last week with the DXY index dropping 1.2%, fuelled mainly by gains for the euro last Thursday after the ECB easing measures failed to encourage fresh EUR/USD selling. Key Quotes “Perhaps part of the failure of the ECB to encourage renewed EUR/USD selling was the fact that market participants were looking ahead to this Wednesday’s Fed meeting when the FOMC is expected to remain on hold and cut the Fed Funds DOTS profile by at least 25bps to a median level of 1.125%, implying three rather than four 25bp rate increases through the remainder of 2016. Fed Chair Yellen will have to provide reasoning for this in her press conference following the announcement. We expect that to be quite difficult. In reality, if the FOMC were true to its word on their decisions being data-dependent, it is hard to disagree with the view that the FOMC should be raising rates on Wednesday. Consumer spending looks to have rebounded since the start of 2016, the ISM data suggests the manufacturing sector may have stabilised, the jobs data points to a continued tightening of the labour market while measures of both actual and expected inflation have moved higher. The only justification for the FOMC to continue on hold, which was pointed out in the policy statement in January, was the conditions in broader financial markets. Even on that front, the reasons for delaying rate hikes have receded notably. NYMEX crude oil prices are up over 20% since the January FOMC meeting, the S&P 500 is 6.2% higher and the DXY index is close to 3.0% lower. So we suspect that the statement on Wednesday and Fed Chair Yellen in her comments will acknowledge these improvements and will therefore conclude that conditions are again falling into place for a resumption in rate hikes. One clear way for that to be signalled in the statement would be for the balance of risks bias, which was dropped in January, to be reinstated with the FOMC concluding that the balance of risks have returned to “nearly balanced”, or perhaps even fully balanced. This would be justified given the changes in inflation expectations and the jump in the core PCE price index from 1.4% to 1.7% on an annual basis. Hence, we see grounds for Wednesday’s FOMC meeting being supportive for the US dollar. But we understand the scepticism of the market. Given the delay in rate hikes and the likely cut to the DOTS profile, there is an expectation of Yellen needing to be somewhat dovish in order to explain these facts. Furthermore, the dollar last year performed poorly on the actual day of press conference FOMC meetings. The DXY index fell at each one of those four occasions last year, by an average of -0.75%. However, within five days of those meetings, the dollar had more than recovered the initial loss in three of the four occasions. We’d certainly expect the dollar to be stronger over a five-day period on this occasion too – assuming the FOMC does its job of signalling to the market that it will need to be more active in raising rates than current market expectations based on current economic conditions.” For more information, read our latest forex news.