The Fed is entering a transition period in which a new Chair is expected to set the tone for monetary policy. This creates some market uncertainty, which could affect dollar pairs. It’s particularly acute this time around, given US President Donald Trump’s push to lower rates, and questions about how responsive the Fed will be to the data.
This week brings the release of US FOMC minutes, along with a barrage of key data that could guide monetary policy. What could add additional volatility to the market is a divergence in views among policymakers on how to interpret the data. There is a clear division in views at the Fed, even though they are looking at the same data. While some call for several more rate cuts, others advocate keeping rates unchanged. Traders are likely to consider the data alongside comments from Fed officials to determine when to expect the next rate cut.
The Fed Isn’t Cutting Soon
After last week’s stronger-than-expected NFP data, markets have effectively priced out a rate cut at the next FOMC meeting in March. This gave the dollar a little boost, but, as usual, shifts in monetary policy only support the greenback for a short while. If interest rates remain elevated, the US economy is less likely to grow, which reduces demand for dollar-denominated assets. That pattern could repeat, depending on what the upcoming data shows.
The market is pricing in the next Fed cut for June or even July, and it would take a substantial drop in inflation to bring that date forward. On the other hand, another surprisingly strong result for the US economy could mean that Fed hawks are running out of excuses to cut rates, and that could finally support the dollar in a more substantial way.
What the Market is Looking For
First is the release of the minutes from the FOMC’s last meeting, which come out on Wednesday. The meeting was largely uneventful, as the Fed held rates unchanged as expected. The statement focused on the Fed’s independence, coming days after Fed Chair Jerome Powell revealed the DOJ’s probe into the institution’s spending on renovating its headquarters. Traders could now focus more on the monetary policy outlook and on whether there was greater emphasis on jobs or on inflation.
Then the focus turns to Friday, with the simultaneous release of US Q4 GDP figures and the Fed’s preferred inflation measure, the core PCE price index. The US economy is expected to have slowed to an annual growth rate of 3.0% in Q4, down from 4.4% in Q3. Meanwhile, the core PCE price index is anticipated to stay unchanged at 2.8%, above the Fed’s 2.0% target.
The Potential Market Reaction
After the strong January NFP figures, FOMC doves have pivoted toward inflation, saying it is declining as the effects of tariffs on consumer prices wear off. This means that inflation would have to continue to decelerate for the market to expect further rate cuts. An uptick in inflation would likely lead to a further pushback on when the Fed will ease, temporarily helping the dollar.
On the other hand, a slowing economy could mean that January NFP data is an outlier and restricts the Fed’s room to keep rates elevated. If US GDP is cooler than anticipated, then the dollar could weaken as traders expect more easing from the Fed.