It’s a big day for the US markets. It’s a big day for the dollar. The US monetary policymakers will reveal the pace of their asset tapering, the current status of inflation and when it could start hiking rates. Meanwhile, the dollar remains upbeat as the index stays firm above 94. 

During and after the pandemic, major central banks’ efforts to ease the economy included cutting back on rates and consistent asset and bond purchases. However, with the reach of vaccines to almost every corner of the earth which resulted in lockdown eases and economies rebound, the banks have started to reverse their actions. This came with a price of course – Inflation. The BoC last week ended its asset purchases abruptly while the Reserve Bank of New Zealand went further to hike rates. It’s inevitable as inflation continues to push for policy review. Even the dovish ECB has wet the ground for stimulus easing.

The biggest of them all, the US Federal Reserve Bank, has already agreed on tapering asset purchases gradually until the next year. The plan, according to the head of the bank, Jerome Powell, was to complete this process before rate hikes follow. Therefore, the pace of the cutback, which will be known today during their policy statements and press conference in the early hours of the New York session, will help traders and investors to predict when the bank will start hiking rates. It seems that the market has priced in tapering before today but the size of the cut could mean something

According to many reports, a $15 billion monthly cut will ensure the process is complete in 8 months or less and will allow the bank to hike rates at least twice in 2022 from the Q2 to Q4 of the year. A rate hike seems to be unlikely in 2022 Q1. This seems to be the market’s underlying sentiment which the outcome will be weighed against. Aside from this, investors and traders will factor in the statement on inflation.

At the start of the year, the major concern of the central banks has been employment and inflation. With the Fed satisfied with the pace of job recovery, inflation is now the major concern of policymakers. In recent months, the Fed has admitted that inflation might not be 100% transitory as it earlier believed. What are the different scenarios we could get from the event and how could the dollar respond?

What are the different scenarios?

If the bank decides to taper from $15-20 billion monthly QE, we should see a minor dollar gain. This scenario has been priced in. The dollar index will most likely maintain the bullish trend up to 95 anyways. However, taper at the expected pace with hawkish inflation remort might slow the dollar rally. We might even see a bit of a decline before the trend restarts. On the other hand, a dovish inflation report should increase the pace of the dollar rally. With inflation getting out of hand, investors might price in faster taper pace in the coming monetary meetings which will quicken the rate hike timeline.

Also, an excessive cut beyond expectation will quicken the dollar rally. Adding that to a dovish inflation outlook, the dollar will be expected to dominate other FX for the rest of the week before Friday’s job reports.

On the other hand, a cut of $10 billion or below monthly might push the dollar downside especially if it comes with a hawkish inflation outlook. That would mean the bank is not in a hurry to loosen its policies and will allow the economy to breathe further. This rate hike could be projected to happen once next year and at the tail as well. Could be bearish for the dollar against its peers as policy divergence will take the advantage away from the buck.

Dollar Index Technical Analysis

Dollar Index (Daily)

The dollar still maintained its dominance since the turn of the year. However, the move is corrective. With 94 not being able to hold, the index might proceed to 95 with a bullish dollar expected this week. The chart shows an emerging diagonal/wedge reversal pattern. We will most likely see a strong resistance around 95 that the dollar bulls might not be able to beat.

Dollar Index (H2)

The wedge/diagonal formation completed the 4th leg at 92.35 and then followed an impulse rally before the current minor dip. 93.25 is expected to hold as the index breaks above 94.3 toward the 95 key psychological level. This will happen quickly if the FOMC outcome today supports the dollar which is very likely. Traders can use the outcome for their preferred major FX pairs.

On the other hand, a dip below 92.35 will shatter the bullish development and might be the start of a long-term dollar fall.

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