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US dollar rallies after the Fed signal March as rate lift-off

The widely anticipated FOMC meeting delivered on expectations which was essentially a lot of forward guidance and now actual changes to the policy. The markets are re-pricing the US dollar higher based on the March FOMC date and the risk will be if the Fed decides to not raise rates when it comes to the next meeting. This could be for any number of reasons, but in particular, I am thinking tensions around Ukraine, should things escalate.

Market Brief

Before we get into what happened in the charts, the big news is that nothing changed at the January FOMC meeting other than they announced that they will “soon” raise rates. They will finish the asset purchase taper by March, and they will look to reduce the assets they hold after they begin the rate hike cycle. So what does “soon” mean, well if you are a market watcher that means at the time of writing in 48 days and 10 hour’s time. But the clever Fed speak is leaving the door ajar for any time they feel is right depending on what is happening in the geopolitical space and underlying economy. All of what happened yesterday was in line with expectations, so the bigger risk event is the March FOMC meeting where they could disappoint by not raising rates, or they could make the market re-price on the back of a greater rate hike than is currently expected.

So, considering everything is as expected today, what is driving the markets?

The forex heatmap shows flow coming out of the Antipodean and commodity pairs and flows into the safe-haven yen and Swiss franc. The US dollar is bid up to and the strongest currency relative to its peers.

The EURUSD has fallen sharply, and the next logical test below is the rising trend line support and the 1.0800 level. The ActicTrader sentiment indicator shows that over 80% of traders on the platform are bullish on the EURUSD so there is no way I see this getting a dead cat bounce until those traders who are long get stopped out.

The US dollar index is pushing for a weekly close at or above the $97 price level. If we breach that, the consolidation period could be over and the rise to $99 can continue.

With the Fed only 7 weeks away from the market expecting the rate hike cycle to begin the US treasury yields are steepening at the short end. Apart from the inversion at the long end where the 20Y is above the 30Y yields, everything looks normal. If we see the short end rate rise to or above the same levels as the belly and long end of the curve, the market top is very likely in and a larger correction than what we are seeing now will occur. The percentage of companies within the S&P500 trading above their 200 DMA is now below 40%, so I am looking to keep selling the rips and corrections to the daily 50-period EMA. Especially as the monthly US government Surplus is now showing it is reached $20bln. There is less money staying within the system so less money will flow to corporate profits. Quantitative Easing was the asset swap between the Fed-created reserves that they used to remove Treasuries from the prime banks. The idea behind the QE was to keep the short-term interest rates low as demand boosts the price and lowers yield. Thus, allowing net borrowers, to borrow cheaper. With the Fed reversing QE to QT they will be buying fewer short-term treasuries and that in itself will raise the short-term yields higher. My thinking is that if they conduct QT and raise the Federal Funds Rate in March by any measure, we will see the yield curve flattening off and that would be the setup for the next recession.

I am expecting today's US advanced GDP data to show a weakening or a trend to the downside and that the weekly initial jobless claims to have risen again. For those looking to see if the inflation is transitory, even though Fed Chair Powell retired that word, the US durable goods data should shed some light on the current supply chain disruptions.

Being short a commodity pair like the New Zealand dollar against the US dollar would be my trade of choice. There are at least 300 pips to the downside, so a stop loss 150 pips higher would be a decent trade. Waiting for a retest of old support to act as resistance would put the odds in your favour but also give you a larger risk-reward ratio.