USD retests critical weekly support: What next?
At the commence of last week, USD over Sunday/Monday made a strong advance to the north, in what looked to be a continuation of the gains seen in the prior week. However, as the week progressed, bullish momentum for the greenback was lost. It appeared to be more of a technical move, rather than anything fundamental. The US Dollar Index had run into a heavy supply region up at 92.25-50 - an area that if broken down can provide huge upside potential, as seen in 2018. Following the failed break above, it was forced to retest 91.50, a former proven level of resistance, as observed in February. Given that the above-detailed retest managed to hold on Friday, it has now provided a decent foundation and opportunity for the bulls to make another attempt at breaking down the noted supply area. Technically, a convincing breakout and retest of 92.25-50 via the daily chart would be enough to encourage another wave of buying pressure.
Make or Break: FOMC rate decision in focus
In terms of this meeting, it is unlikely to see any changes in policy, more focus will be centred around the central bank providing more commentary on its thinking about the pace of the economic recovery, and whether a faster-than-expected rebound might warrant a nearer-term adjustment to the Fed's policy.
Economic forecasts
The FOMC economic forecasts are expected to demonstrate the improved growth picture this year, and some transitory inflationary pressures as well. However will continue to show a long road towards solid conditions for maximum employment, which would put sustained pressure on inflation.
Inflation
So far, Powell and other FOMC officials have said that the Fed would leave policy as is even if the economy experiences a stint of above-target inflation, to compensate for the years of below-target inflationary pressures.
There has been some worry across the market regarding the likelihood of an unchecked jump in inflation later this year, with more businesses reopening and a large pick up of consumer demand. Keeping this possibility in mind, there are fears that it could force the Fed to react by moving faster than it has currently communicated by quickly raising interest rates, slowing asset purchases, and otherwise tightening monetary policy to fend off inflationary pressures.
These views have somewhat manifested in the fixed-income markets, with the 10-year Treasury yield climbing to the highest levels seen in over a year. It has been in anticipation of a strong economic recovery and of a possibly earlier than expected Fed move.
However, in a recent speech, Powell has said that he believes any signs of inflation in the economic data this year would be short-term. He has also maintained that the move higher in Treasury yields reflects an improving outlook on economic growth — a stance he is likely to reiterate during this week's press conference.
In Summary
No shifts in a policy expected from the FOMC with respect to ongoing volatility in the Treasury market. Chair Powell will likely cover ground again on the Fed’s current forward guidance and flexible average inflation targeting (FAIT) for short-term rates in order to push back on current market lift-off pricing. Powell could simply reiterate that recent increases in long-term rates likely reflect increased optimism over the recovery, however, the situation will be monitored.
Reaction for USD: The above scenario would be not so dovish and could very well further support USD to the upside.