Why Fed policy will continue to dictate market sentiment

With US data running hot on all fronts, market participants are positioning themselves for a more hawkish Fed

A trader at the New York Stock Exchange. Overall, markets remain in limbo as they await Fed policy decision. Reuters

The US dollar has staged an impressive comeback so far in February.

After hitting 10-month lows, the US Dollar Index — a measure of the greenback against a weighted basket of major currencies — has rallied more than 1.7 per cent to recoup all its January losses.

The greenback has been buoyed by a series of strong US data points this month.

The January payroll data came in at more than half a million jobs added, almost three times market expectations.

This was followed by last week’s US inflation print, which showed that year-on-year prices were still stubbornly high at 6.4 per cent, a smaller decrease than markets had expected.

With US data still running hot on all fronts, market participants are positioning themselves for a more hawkish US Federal Reserve, which is looking increasingly likely to maintain its current interest rate rise trajectory.

Futures markets suggest that rates would peak at more than 5.2 per cent this year, up from 4.9 per cent at the start of February.

This suggests that the dollar rally is likely to be more entrenched through to the end of the first quarter.

As always, US data points will need to be closely scrutinised — and comments from the Fed and its chairman Jerome Powell will be of utmost importance.

On Wednesday, the minutes of the Federal Open Market Committee meeting from the most recent Fed rate decision on February 1 will be released.

Recall that a few members had called for a 50-basis-point rise during the March meeting — and if the minutes reinforce this view, we could be in for another bout of dollar buying.

This will be followed by overall US gross domestic product (GDP) data due on Thursday (expectations are for fourth-quarter GDP to come in at 2.9 per cent year on year) and the Personal Consumption Expenditure price index, the Fed’s preferred measure of inflation, scheduled for 5.30pm Dubai time on Friday.

While many on Wall Street do not foresee a continuation in the strong run of US data points, there is some steam in the current rally and these data points will need to be watched.

Technically, I expect the US Dollar Index to continue its consolidation in the current channel and maintain a slight bullish bias through to the end of March.

Support at 103.75 needs to hold, with upsides in the short term capped at 104.75/105.00 over the next two months.

The price of gold has been rather choppy during the month. After peaking at $1,960 levels earlier in February, the precious metal slid below $1,850 on the back of a stronger dollar.

Gold will remain volatile in the weeks ahead — and will be driven by the US economy and consequent Fed policy.

Technically, good support is coming in at the 100-day exponential moving average of $1,818 levels, which must hold before talk of $1,800 levels. On the upside, $1,853 will be a tough level to breach.

Across the Atlantic, the euro's prospects faded on the greenback's strength. The common currency slipped more than 1.6 per cent against the dollar in February and found support at 1.06 levels.

Much of the weakness in the euro can be attributed to a rally in the US dollar. However, a deeper look into euro data points would suggest the recovery of the euro area is not as robust as expected.

Despite reducing energy prices, which was a key theme last year, recent data showed that retail sales continue to fall.

German export data remains anaemic, which would also suggest that demand remains challenging within the region and externally.

EUR/USD prospects would point to downsides towards 1.0530 in the months ahead.

Overall, markets remain in limbo as they await Fed policy.

February's pricing action has taught us that we are not out of the woods as yet — the optimism from January must be tapered.

For shorter-term traders, the volatility and current ranges may provide opportunities.

However, perhaps it would prove prudent to wait before making longer-term positional trades.

Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers