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  • Investors scale back Fed rate cut bets as inflation stays hot
  • But economic growth slows more than expected in Q1
  • Will the Fed continue to signal patience?
  • The Committee decides on Wednesday at 18:00 GMT

Stubborn inflation weighs on rate cut bets

When they last met, Fed officials left interest rates untouched as it was widely expected, and although they revised up their growth and inflation projections, they continued pointing to three quarter-point rate cuts by the end of the year, which served as a disappointment to those expecting less due to stickier than expected inflation.

Back then, the probability of a first reduction in June rose to around 80% and the total number of basis points worth of reductions by the end of the year was 83. Nonetheless, inflation accelerated further in March and the labor market further tightened, prompting Fed officials to signal that there is no urgency to start loosening, and investors to reevaluate their rate cut bets. This massive repricing supercharged the US dollar, which gained against all its major counterparts and managed to break several key technical levels.


But economy grows by less than expected

Nonetheless, the upbeat momentum in dollar buying did not last for long. The miss in the preliminary S&P Global PMIs for April and the weak first estimate of GDP for Q1 suggest that the world’s largest economy is not faring as greatly as it was previously thought, resulting in some profit taking in dollar long positions.

But the GDP report was not all bad after all. It came with mixed messages. Despite the US economy growing at its slowest pace in nearly two years, domestic demand remained strong, evident by the strong acceleration in PCE prices during the quarter. This confirmed the notion that inflation is much hotter than the Fed would hope and allowed investors to further reduce the amount of basis points worth of rate cuts expected by December, even as they continued selling the dollar. They are now seeing interest rates only 35bps below current levels.


Still higher for longer?

Next week’s Fed meeting will be one of the smaller ones that are not accompanied by new economic projections nor an updated dot plot. Thus, all the attention will fall on the statement and the press conference by Fed Chair Powell for clues on whether rate cuts are still warranted this year, and if so, how many.

If officials hint that interest rates should stay at current levels to ensure that inflation will return to their 2% objective, Treasury yields may continue to rise, and the dollar could stage a comeback as market participants further lift their implied rate path. However, anything leaving the door open to more than one rate reduction to avoid a deeper economic slowdown could come as a disappointment and thereby dollar traders may liquidate more of their long positions.


Euro/dollar returns within a range

From a technical standpoint, euro/dollar has been in a recovery mode lately, managing to poke its nose back above 1.0725, the level that acted as the lower bound of the sideways range that contained most of the price action between mid-November and April 11.


The recovery may continue for a while longer within the range, but a hawkish Fed may encourage the sellers to take charge from below the 1.0800 zone, near the 50- and 200-day exponential moving averages (EMAs) and push the pair back down to the 1.0725 zone. A break lower could carry more bearish implications, perhaps paving the way towards the 1.0610 zone that provided support between April 16 and 19.

Alternatively, a dovish Fed may drive euro/dollar above the EMAs and initially aim for the 1.0875 area. However, the pair would still be within the aforementioned range and thus, the broader outlook would still be neutral. For the picture to be considered bullish, a break above 1.0940 may be needed.

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