Euro, EUR/USD, US Dollar, Bond Yields, FOMC– Talking Points
- EUR/USD may rise on FOMC policy decision outside of surprise 25 basis point hike
- US Dollar and Treasury yields appear to have largely priced in more aggressive Fed
- That leaves the door open for pre-FOMC trades to unwind partially, boosting the Euro
The Euro may be primed to move higher versus the US Dollar, the possible trigger: tonight's Federal Open Market Committee (FOMC) policy decision. The US central bank is expected to hold rates steady, although there is an outside chance of a 25 basis point rate hike. According to Fed funds futures, that chance is right around 5.6 percent. On the outside chance that the Fed does initiate a rate liftoff – the first since the Covid pandemic began back in early 2020 – it would likely bolster the US Dollar and send EUR/USD lower.
However, if the Federal Reserve meeting comes and goes as expected, EUR/USD would likely rise. That is because traders have largely baked in much firmer expectations for a March rate hike. Sustained inflation amid a surprisingly strong but still recovering labor market has forced the Fed onto the path of normalizing policy. The chance for a 25 basis point rate hike in March has gone from 53.6% to 88.2% over the past month.
That has pushed Treasury yields higher across the curve, but short-term 2- and 5-year rates have outpaced longer-dated yields. The US Dollar is particularly sensitive to those shorter-term rates. The hawkish repricing around the increasing Fed rate hike bets has been the primary factor pushing the EUR/USD exchange rate lower. For reference, short-dated European government bond yields are down since the start of the year.
This opens a path for the Euro to move higher against the US Dollar once the Federal Reserve's policy meeting passes. The adage“buy the rumor, sell the news” looks like it will be a good guide for trading around tonight's FOMC meeting, given that the US Dollar and Treasury yields have certainly bought the rumor in recent weeks. Even with no surprise rate hike, the Fed is likely to communicate more concise plans on reducing its balance sheet – perhaps even directly selling versus letting assets“roll off.” Once the FOMC event passes, the“sell the news” may translate into selling the Dollar.
The Euro is down over half a percent versus the Greenback in January. While it may be wishful thinking to hope for a full retracement, going long EUR/USD may be a popular trade tonight, assuming we don't get a surprise 25 basis point hike. Moreover, US equities have sold off sharply over the past two weeks, with the Nasdaq in correction territory. The passing of the Fed's policy meeting will remove event risks from the market and likely fuel some upside for the embattled stock market. That would likely sap the Greenback's haven appeal and benefit the EUR/USD exchange rate.
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--- Written by Thomas Westwater, Analyst for DailyFX.com
To contact Thomas, use the comments section below or @FxWestwater on Twitter
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