Forex Today: Markets brace for latest Fed rate call

The US Dollar eased slightly as investors pivot toward the Federal Reserve’s (Fed) latest rate call due in the middle of the week. Sentiment is riding on the high side, albeit cautiously, as markets widely anticipate a third straight quarter-point rate cut from the Fed.

Here’s what you need to know heading into Tuesday, December 17:

The US Dollar Index (DXY) eased one-sixth of a percent lower on Monday, crimping recent gains and pausing at the top of a near-term bull run as markets await the Fed’s latest rate call slated for Wednesday. A 25 bps rate trim is fully priced in with 99.1% odds, according to the CME’s FedWatch Tool. Traders will also be keeping a close eye on the Fed’s latest update to its Summary of Economic Projections (SEP), or the “dot plot” of interest rate forecasts from Fed policymakers themselves.

US Purchasing Managers Index (PMI) figures for December came in mixed on Monday, with Services PMI survey results rising to multi-year highs and the Manufacturing component sinking further than expected in a sharp pullback, falling away from the 50.0 midline and plunging back into contractionary expectations territory. US Retail Sales figures will land on Tuesday, but could see a crimped market response as the Fed’s last rate call of the year hulking just around the corner.

EUR/USD cycled familiar levels near 1.0500 to kick off the new trading week as markets broadly ignored a flurry of appearances from European Central Bank officials early in the day. European PMI figures for December broadly beat expectations. Still, Services PMI surveys remain stumped in contraction territory as worries of a steepening economic slowdown across European continue to grip investors and business operators.

GBP/USD snapped a three-day losing streak, clawing back 0.55% through Monday’s trading and pushing bids back into the 1.2700 handle. UK Services PMI figures fell to an 11-month low, but a welcome uptick in the Manufacturing component helped to keep Cable sentiment bolstered into the high end. GBP traders will now be focusing on Tuesday’s upcoming UK wages and labor data, where quarterly Average Earnings are expected to accelerate to 5% on a yearly basis.

USD/JPY climbed back above the 154.00 handle on Monday, climbing a little under one-third of one percent. The Japanese segment of this week’s economic data docket is a thin affair, but the Bank of Japan’s (BoJ) latest rate call is looming ahead on Thursday. The BoJ is broadly expected to keep rates on hold yet again in December, and investors are looking to understand exactly what conditions would convince the Japanese central bank to continue raising interest rates.

Economic Indicator

Fed Interest Rate Decision

The Federal Reserve (Fed) deliberates on monetary policy and makes a decision on interest rates at eight pre-scheduled meetings per year. It has two mandates: to keep inflation at 2%, and to maintain full employment. Its main tool for achieving this is by setting interest rates – both at which it lends to banks and banks lend to each other. If it decides to hike rates, the US Dollar (USD) tends to strengthen as it attracts more foreign capital inflows. If it cuts rates, it tends to weaken the USD as capital drains out to countries offering higher returns. If rates are left unchanged, attention turns to the tone of the Federal Open Market Committee (FOMC) statement, and whether it is hawkish (expectant of higher future interest rates), or dovish (expectant of lower future rates).

Fed FAQs

What does the Federal Reserve do, how does it impact the US Dollar?

Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.

How often does the Fed hold monetary policy meetings?

The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.

What is Quantitative Easing (QE) and how does it impact USD?

In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.

What is Quantitative Tightening (QT) and how does it impact the US Dollar?

Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.

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