FOMC Preview: Will Powell Lose His Cool?

In a week with heavy data, Wednesday’s Federal Reserve monetary policy announcement will be the most important event risk. The Fed is set to update its economic projections and its outlook for interest rates. Chairman Jerome Powell will hold his usual press conference, where he will undoubtedly be peppered with questions about yields. 

 

The U.S. dollar shrugged off the February retail sales report and consolidated its gains ahead of the rate decision. The greenback avoided losses against most of the major currencies. USD/JPY and USD/CHF succumbed to profit-taking. Retail sales dropped 3% in the month of February, which was significantly weaker than the -0.5% forecast. Excluding autos, spending dropped 2.7%, which was also worse than anticipated. However, these numbers did not hurt the U.S. dollar because January retail sales figures were revised higher and, on a seasonally adjusted basis, spending was strong despite winter storms. Also, with stimulus checks set to go out as early as next week, many investors are looking forward to stronger retail sales in the second half of March and April.

 

There are three main questions for the Fed tomorrow:

 

1.    How will GDP and inflation forecasts change?

 

2.    Will the “dot plot” of interest rate projections signal a 2022 rate hike?

 

3.    Does Powell still see a rise in inflation as temporary and the jump in yields a non-issue?

 

What makes this month’s FOMC meeting so important is that there could be big moves in currencies, Treasuries and equities regardless of what Powell says. Powell made in clear in recent comments that he’s not worried. But but how long can U.S. policy-makers remain cool if yields continue to shoot higher? For the past month, he has downplayed the rise in inflation and move in yields. By continuing to do so, he’s basically giving a green light or endorsing further gains, which would be positive for the U.S. dollar. However, if he starts to share some of the European Central Bank’s concerns or decides to shift the Fed’s purchases to longer dated bonds, which affect mortgage rates, yields and the U.S. dollar could sink quickly.

 

The Canadian dollar rose to fresh three-year highs against the greenback despite lower oil prices. Weaker U.S. retail sales contributed to the move along with expectations for stronger Canadian data. Inflation and retail sales numbers are due for release this week. February was a better month for Canada, and while the IVEY PMI index showed softer price pressures, the rise in commodity prices is expected to drive CPI higher. Economists are looking for a modest 0.7% increase last month versus 0.6% in January. On an annualized basis, CPI will still be running well below 2%, so rising price pressures is not a major problem for the Bank of Canada.

 

At the start of the U.S. trading session, the euro traded strongly on the back of a firmer ZEW survey. However by the end of the day, it had given up all of its gains. The region is still mired in slow vaccine rollout and a dovish central bank that accelerated asset purchases to keep a lid on bond yields. The Australian dollar remained under pressure after the RBA minutes revealed a central bank committed to maintaining “very significant,” “stimulatory monetary conditions” for some time. It has no plans to tighten monetary policy until inflation is sustainably between the 2-to-3% range. 

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