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USD Eyes Storm on Horizon with FOMC Meeting Tomorrow

USD Eyes Storm on Horizon with FOMC Meeting Tomorrow

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- Like barometric pressure dropping before a thunderstorm, market volatility has cooled off as is typical in the run-up to a FOMC rate decision.

- USD/JPY looks like the best candidate for USD-strength at present time given the US Treasury 10-year yield's ongoing run higher.

- Retail crowd positioning has eased, but remains near extreme levels in a few USD-pairs.

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With the Federal Reserve starting its two day meeting today, culminating in the release of the policy statement and a new summary of economic projections tomorrow at 14 EDT/18 GMT, the US Dollar has officially moved into the eye of the storm. As is typical in the 24-48 hours ahead of a FOMC decision, volatility across USD-pairs has dropped, much like how the barometric pressure of the atmosphere drops before the onset of a thunderstorm.

The severity of the incoming storm for the US Dollar will by and large depend on the degree of hawkishness the Fed employs. A rate hike is out of the question; Fed funds futures are pricing in a 0% chance of a 25-bps move tomorrow. Instead, the most likely best outcome for the US Dollar revolves around whether or not the Fed announces the beginning of its balance sheet unwind.

Effectively 'quantitative tightening,' the balance sheet unwind will be the withdrawal of stimulus from the US economy. Given the underlying instruments - Treasuries and agency mortgage-backed securities - it would appear that a balance sheet unwind announcement should help buoy long-end US yields. In turn, widening interest rate differentials and a steeper yield curve, over time, should help the US Dollar stabilize and break its 2017 downtrend.

Ahead of the FOMC meeting tomorrow, it's necessary to reiterate that it's still too soon to say that a low is in place for the US Dollar on a broad basis. The DXY Index tested its daily 21-EMA last week, only to fail to close above it; it hasn't closed above its daily 21-EMA since June 22. Aside from the daily 21-EMA (now at 92.43), traders may want to wait for further confirmation for a DXY Index low until the August 25 bearish outside engulfing bar is cleared out at 93.44.

Chart 1: Inverse USD/CHF, Inverse USD/JPY, Gold, & US Treasury 10-year Yield Hourly Timeframe (September 2017)

USD Eyes Storm on Horizon with FOMC Meeting Tomorrow

Accordingly, selection for long USD exposure needs to be discriminatory until the DXY Index turns the corner. The most appealing places right now might be USD/JPY and USD/CHF, given these pairs' sensitivity to US interest rates and their relationship to risk dynamics. Throughout September, Gold, US yields, USD/CHF, and USD/JPY have traded synchronously, and this should continue to persist through the FOMC meeting this week.

Chart 2: USD/JPY Daily Timeframe (April to September 2017)

USD Eyes Storm on Horizon with FOMC Meeting Tomorrow

With the US Treasury 10-year yield testing the August 23 outside engulfing bar high at 2.224% today, USD/JPY looks well-established above its 111.05 swing level from late-July/early-August. Concurrently, USD/CHF is turning higher in the middle of its four-month range, and eyes a return to 0.9730/70 in the coming sessions. These biases are bolstered by the breakdown in Gold, which is trading below its rising trendline from the July and August swing lows as well as below its daily 21-EMA for the first time since July 18.

See the above video for technical considerations in the DXY Index, EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD, and Gold.

Read more: FX Markets Await Results of FOMC, BOJ Meetings, Canadian CPI

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

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