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A hawkish Fed and volatility are expected in the coming hours

If you have made it through the volatility this week, congratulations. The focus of the week has been split between the outcome of the FOMC meeting and also the geopolitical tensions building at the borders of Ukraine. By the end of the day, we should have a better idea of what the Fed will do in the coming months and we’ll keep our fingers crossed the politics doesn’t scupper out trade ideas.

It has been a relatively quiet overnight session as traders pause ahead of the FOMC. This may be the calm before the storm, with expectations high for a rate hike in March.

There is a small margin of chance that the Fed comes out today with a rate hike and that would be a volatile re-pricing in the markets if they get that surprise. There is an 88% chance currently that the Fed raise rates by 25bps or more in March, so today’s risk event would be if the Fed signal that they are getting cold feet due to the geopolitical uncertainties or the underlying market conditions don’t favour a rate hike somehow. If all goes as expected the markets may decide they have already repriced for the news, and we get a very flat end to Wednesday. The good news is that we find out today, so there should be no rush to get involved ahead of the decisions and press conference. If you find yourself in a trade that is likely to be affected by the volatility, it would be prudent to mitigate your risk or close out positions ahead of the news.

The US dollar index has found its equilibrium at $96 which gives it space to just as easily go to $100 as it could to$90. Trading in the middle of the range like this would be asking for trouble as the market makers will very likely test the recent swing highs and lows as they build up their order books.

One key data point is the ActivTrader sentiment indicator which shows that a large percentage of traders are bullish on the US dollar. 87% is an extreme reading, so as a contrarian to what the retail traders will be looking for, any opportunity to sell a rip will be my go-to trade idea. For the US dollar to drop we’d have to see the benchmark yields fall too, which would suggest the market doesn’t like what they hear from the Fed today. Since 2021 the overall correlation between the US dollar index and US 10-year yields have not always been closely matched, but they are quite similar at the moment.

The USDCAD finally rejected the 1.2600 level which had been previous support. The most logical place to trade now is the previous swing lows with a take profit order #1 around the 1.2500 level, with an eye on the 1.2300 if we get some bearish momentum in the DXY or bullish continuation in the energy markets.

The forex heatmap is suggesting that the London session has started with a risk-on theme with safe havens being rejected in favour of the commodity pairs. The Canadian dollar is leading the way, but the Aussie is a close second. The single currency is weakening ahead of a German bond auction. The Canadian dollar could appreciate further if the Bank of Canada tightens monetary policy again today with any hawkish changes to the overnight rate or asset purchase programme. The Bank of Canada press conference is scheduled for 4 pm GMT today.

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