Fed Preview: USD Weakness Most Likely Outcome

Above: Federal Reserve Chairman Jerome Powell. Image © Federal Reserve.

With UK inflation not offering much direction for the Pound to Dollar, all eyes now turn to the Federal Reserve policy update, due at 18:00 UK time.

The Fed will leave interest rates unchanged but release new forecasts and guidance, potentially challenging current market assumptions that the first rate cut will be delivered in June.

Analysts at TD Securities say their base case expectation (60% odds) is for the Dollar to depreciate by approximately 0.20%.

All else equal, this would amount to a decent recovery in the Pound-Dollar exchange rate to approximately 1.2720.

"Risk-reward under our baseline of the Fed's 2024 dot remaining unchanged in a market that is net long the dollar is for USD weakness," says Jayati Bharadwaj, FX Strategist at TD Securities.

Under the base case scenario, the strategy team at TD Securities looks for guidance to be broadly unchanged, with a slight lift in the Fed's dot plot profile. The dot plot chart is a key communication tool that shows where members of the Committee expect interest rates to be in the future.

Where the dots move could be the most significant aspect of the March policy update.

Markets expect the dots to move slightly higher (particularly the longer-term dots) in response to ongoing economic resilience and signs the U.S. disinflation trend has slowed. There is a risk the 2024 dots move higher too.

Indeed, under a 'hawkish' scenario (35%), TD Securities expects the "2024 dots to move higher and Fed raises long-run dot."

Here, the Dollar could move higher by 0.35%, which implies a chunky downside in Pound-Dollar and confirmation that the near-term trend is turning lower.

Under this scenario, the Fed would warn that rates might have to stay higher for longer as "while inflation has moved closer to the objective, there's no guarantee that it will stay sustainably at the 2% target," explains TD Securities.

The Dollar could fall by as much as 0.50% under a 'dovish' scenario (just 5% odds), in which TD Securities expects the Fed's guidance to be tweaked to signal that the Committee is close to gaining full confidence that inflation is "moving sustainably" toward the 2% target.

Here, all dots remain unchanged.

A further signal would come from Fed Chair Jerome Powell's acknowledgement that despite recent firmer inflation, "it is likely to represent a bump in the downtrend".