The USD eases after three-day subsequent gains and investors turn their focus to the Federal Reserve meeting later today. The Fed Committee will conclude it’s two-day meeting on Wednesday amid concerns on how higher rates could affect the aching economy. Investors around the world await the highly anticipated meeting as well as Fed’s chair Jerome Powell remarks at the press conference for more clues on how far the committee would rise interest rates this year.
January has been a gracious month for the stock market compared to last year’s performance. The S&P 500 has seen an impressive 4.6% increase since the start of the year. The Federal Open Market Committee meeting could be the deciding factor in whether or not this market momentum continues. It all boils down to how much of an interest rate increase is decided on at the FOMC meeting.
Economy Overview
Inflation Rate
For the sixth consecutive month, US annual inflation rate decelerated to 6.5% in December 2022 as expected, its lowest since October 2021. This follows the November reading of 7.1%. Notably, energy cost rose by only 7.3%, much lower than 13.1% from a month earlier; gasoline expenses even dropped by 1.5%, after a 10.1% spike in November.
On a monthly basis, the CPI fell 0.1% for the first time since May of 2020, a surprise given that economists had expected it to remain flat. Inflation seems to have peaked in June of 2022 at 9.1%. Albeit slowing, inflation is still three times higher than the Federal Reserve’s 2% target rate.
Hopefully, inflation will trend downward otherwise the Federal Reserve would need to continue policy tightening – which could push the economy into a recession.
Unemployment Rate
Last December, the US unemployment rate exceeded market expectations by dropping to 3.5% – a record low since February 2020 and matching rates of both July and September that same year.
This followed the drastic drop of weekly jobless claims to a three-month low, along with a slightly lower decrease in November’s employment openings.
This data suggests that the US labor market is still robust and tight, which implies that the Fed will continue its rate hikes at least till inflation downward trend is confirmed.
Sustaining a healthy labor market ensures that the economy stays strong. When job opportunities and wages become more accessible, it is significantly harder for a recession to take hold.
FOMC officials have shared their views that a rise in the unemployment rate is expected while mitigating high inflation. They predict unemployment to rise up to 4.6% from 3.5%.
Economic Growth
The US economy expanded 1% in the fourth quarter of 2022 compared to the same quarter of the previous year.
After showing tremendous growth of 5.9% in 2021, the US GDP expanded more moderately by 2.1% in 2022 as the economy transitioned back to a normal rate of development after pandemic-related disturbances over the past two years.
Consumers made valuable contributions with their spending habits and exports while private inventory investment and nonresidential fixed investment also increased; however, residential fixed investments and federal government spending decreased slightly during this time period while imports rose.
FOMC Preview: What to Expect from the Fed?
After a series of seven rate hikes last year in an effort to contain rising prices, the Fed is likely to shift its monetary policy strategy and become less aggressive with any further interest rates rises until they eventually come to a halt.
Last year, interest rates rose to 4.25% and another 50bps hike is predicated to take place in 2023.
Markets are expecting US rates to peak at 5% this year.
It is widely anticipated that the Federal Reserve will raise the target rate by 0.25%, a quarter percentage point, in its meeting later today. The Fed will announce its rate decision at 7:00 PM GMT.
While a 50 basis point rate hike from the Fed could be possible as it was done at their last meeting, but it appears unlikely.
According to the FedWatch tool, 99.3% expect a 25bps rate hike while 0.7% see a rate cut. Which is also unlikely at this moment.
The FOMC committee faces a difficult task of moderating inflation while preventing an economic recession. Investors in the stock market will be looking to Powell’s post-meeting press conference for answers on how much higher interest rates need to increase before the bank decides it is time to stop, as well as what signs policymakers must see before making that decision.
New Voters
Every year, the Federal Reserve’s policymaking committee that determines interest rate adjustments undergoes a moderate amendment. Four of the district presidents are replaced with new ones as official voting members while four others rotate in.
A more accommodative group of policymakers will take the helm in 2023, making it a pivotal year for both the Federal Reserve and the economy. This year, the Federal Open Market Committee has elected four new voting members to represent diverse regions of the United States; Austan Goolsbee, president of Chicago Fed; Patrick Harker head of Philadelphia Fed; Lorie Logan began her post as Dallas Fed president, and Neel Kashkari the head of Minneapolis Fed.
The voting members set to step down this month are James Bullard of the St. Louis Fed, Susan Collins of the Boston Fed, Esther George from Kansas City, and Loretta Mester representing Cleveland.
The Federal Open Market Committee (FOMC) is composed of the same majority, with eight out of twelve voting members carrying over from last year. Even the non-voting bodies have their moment to contribute and vocalize their ideas during meetings.
USD Eases ahead of the Fed Meeting
The US Dollar Index (DXY) is trading 0.15% lower on Wednesday at 101.94 following three days of consecutive gains. The breach of the 102.00 handle keeps DXY under pressures that could push the greenback to revisit January’s low of 101.50.
As the Federal Reserve and European Central Bank prepare to set their respective policies, EUR/USD is struggling to climb above 1.0870; a continued rally appears uncertain. After briefly reaching the 1.0870 resistance level in Tokyo’s morning session, it appears that the EUR/USD pair is beginning to experience a decline in its upward momentum.
With USD under mounting bearish sentiment, GBP/USD has established a secure support level around 1.2300.
The US dollar has seen remarkable strength against a range of global currencies thanks to the seven increases in rate levels from last year, pushing the target federal funds rate to its highest level since 2006. As the Federal Reserve continues trying to suppress inflation within America’s borders, we anticipate they will further raise rates during their February 1st meeting and possibly once again before quarter-end 2023 – before allowing for a period of pause.
Last year, higher yields were a major contributing factor to the dollar’s upward trend. However, in order to gain an accurate perspective of what may come this year, it is important to consider how much influence this past years’ shocks including Russia-Ukraine war, rising energy prices and stubborn high inflation on the currency’s surge and if these conditions will change during 2023.
The US dollar is likely to experience more depreciation in 2023 as inflation levels recede, recession threats dissipate, and other destabilizing factors start to subside. After hitting a two-decade high last September, the dollar has been on a downward trajectory ever since.
