Scenario analysis ahead of the Federal Reserve’s interest rate decision    

The Federal Reserve of the United States (Fed) will publish the FOMC Statement next Wednesday, followed by a press conference where the Chair, Jerome Powell, will answer questions from financial journalists.

The Fed is widely expected to raise the funds rate by another 25bp. In fact, the target rate probability for the July 26 Fed meeting is 99.8% for another rate hike. It shows what it is already priced in by markets, but, more importantly, this is a metric that the Fed has always respected.

Therefore, it is not a question of if the Fed will hike by another 25bp – that is a given. Instead, it is a question of what will the Fed signal during the press conference – the end of the current tightening cycle or should the market expect more hikes in the near future?

ING sees the Fed hiking 25bp and EUR/USD dropping to 1.1050

ING published an interesting scenario analysis ahead of the Fed meeting. Its base case is that the Fed will hike by 25bp and the EUR/USD exchange rate will drop to 1.1050.

But the most important part of ING’s base case is that it believes that ongoing interest rate increases may be appropriate. Therefore, given that the Fed never moved outside of what the markets had already priced in, any possible surprise should come with the accompanying message.

As such, one can discard the very dovish and hawkish scenarios from the table above because they imply either a no change in the funds rate or a 50bp rate hike.

According to ING, the dovish case would consist of a 25bp rate hike and a signal that future rate hikes are data-dependent. In this case, the EUR/USD is seen at 1.12.

To sum up, this week’s interest rate decision is not about the rate hike but about the accompanying language. A more hawkish Fed may tweak the quantitative tightening program or signal its willingness to fight inflation despite recent progress. On the other hand, a more dovish Fed may signal that the terminal rate for this cycle has been reached.

Either way, the markets are set to move despite already knowing what the Fed will do Wednesday. The trick to trade this upcoming event is correctly interpreting the accompanying message.