The Fed is set to wait and see

The Fed is set to wait and see

·         Markets are awaiting the Fed’s official stance.

·         The ECB does not wish to repeat past mistakes.

The US dollar has entered a consolidation phase ahead of the Fed and ECB meetings and the lull in the Middle East. Central banks intend to adopt a wait-and-see stance amid geopolitical uncertainty. Right now, the US and Iran are playing a game of chicken. Tehran’s proposal to resolve the conflict did not go down well with the White House, which is preparing its own.

In 2008 and 2011, the ECB raised interest rates in response to rising inflation, only to slash them further a couple of months later to rescue the eurozone economy. In 2022, the Bank had already delayed tightening monetary policy for a very long time, allowing inflation to surge to double-digit levels. These are all acknowledged mistakes, and the desire not to repeat them is forcing the European Central Bank to maintain hawkish rhetoric without rushing into actual tightening.  

Bloomberg experts expect Christine Lagarde to hint at a rate hike in June. If investors find these hints unconvincing, the EURUSD risks declining. 

The Fed’s passivity stems from its intention to see how the conflict in the Middle East will affect the US. The post-pandemic recovery, the armed conflict in Ukraine and tariffs have had a temporary impact on the US economy and inflation. 

However, the PCE has remained above the 2% target for a very long time, which risks undermining confidence in the central bank and entrenching higher inflation expectations. In such a situation, even the FOMC doves are speaking hawkishly. For instance, Christopher Waller warns that the Fed will eventually be forced to respond to a host of factors pointing to accelerating inflation.

Just as much as the fate of interest rates, investors are keen to know whether Jerome Powell will remain on the FOMC until 2028 or step down once his term as Chair comes to an end. His departure would allow Donald Trump to increase the number of ‘doves’ and bring forward the timing of a rate cut. It would also make Kevin Warsh’s task of restructuring the Fed easier. 

Fears over the FOMC’s ‘hawkish’ rhetoric in April, coupled with the resulting strengthening of the dollar and rise in US Treasury yields, have acted as a headwind for gold, with the precious metal plummeting to a four-week low. However, if Jerome Powell refrains from hinting at rate rises, gold will have a chance to recover its losses.

By the FxPro Analyst Team