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USD Breakout Needs a Spark - Will FOMC Provide it Tomorrow?

USD Breakout Needs a Spark - Will FOMC Provide it Tomorrow?

Christopher Vecchio, CFA, Senior Strategist

Talking Points

- AUD/USD, USD/JPY reverse course intraday as equities rebound.

- Keep an eye on USD/CAD and Crude Oil.

- Follow trader sentiment in USD/CAD with live DailyFX SSI updates.

The USDOLLAR Index is maintaining its 2016 rally thus far, continuing to hold above its daily 8-EMA, which hasn't seen two consecutive closes below it since December 25-28, 2015. Yet the nature of this rally has been a frail one, with market expectations for rate hikes this year dwindling to barely one; and in turn, participation among the components of the USDOLLAR Index has been far from consistent. We've been skeptical, but the FOMC meeting tomorrow represents a significant hurdle for greenback bears to clear - particularly because it means the Fed would have to admit a policy mistake.

The Fed, as we said in our weekly forecast on the Euro, "Euro Burdened By Prospect of ECB Action in March - Is it a Real Threat?" is in a bind for its next few meetings given the policy path that it has previously discussed: four rates hikes this year, or basically one at every other meeting. With Fed funds futures still only pricing in one hike this year, this means that if the Fed reaffirms its glide path, the market may have to quickly reprice the likelihood of a March rate hike which should support the US Dollar broadly.

Here in lies the conundrum the Fed is facing: what if it chooses to err on the dovish side tomorrow? It could easily make an argument that global risk trends have deteriorated, financial market conditions have tightened, weakness in energy markets has gone further than they had expected, and the strong US Dollar is posing a greater issue for multinationals.

Yet in doing so, they would leave open the nasty possibility of a mismanaged meeting in March: by increasing dovish sentiment at the meeting tomorrow (guiding market expectations for March lower), the possibility of a policy mistake - a rate hike in March after lowering expectations - would upend global financial markets in the short-term and push volatility even higher.

It seems the safer path for the Fed is to stick to its previously intended glide path while highlighting the downside risks afoot in the global economy. Anything more dovish than that seems bound to set up the US Dollar for a very volatile next few months.

See the above video for technical considerations in EUR/USD, USD/CAD, USD/JPY, AUD/USD, and the USDOLLAR Index.

Read more: Commodity Bloc FX Rebound Pauses - Markets Wait for FOMC

Be sure to join me and Currency Analyst James Stanley on Friday, January 29, at 09:00 EST/14:00 GMT for a special webinar discussing the ongoing slide in energy prices and their impact on FX markets.

--- Written by Christopher Vecchio, Currency Strategist

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.