Could the Fed disappoint dovish expectations?

The US dollar has drifted steadily lower in recent days as markets have waited in eager anticipation for the Fed’s monetary policy statement scheduled after its two-day meeting concludes on Wednesday afternoon.

As the Fed has become increasingly dovish since its December rate hike, and in recent weeks and months has essentially led financial markets to rule out an April hike through its members’ mostly dovish public comments, the stage has been set for further delays in the Fed’s monetary tightening plans.

These dovish expectations have been further supported by lackluster inflation and economic growth data, both in the US and globally, during the month of April. With key US inflation data as well as numbers for retail sales, manufacturing, durable goods orders, and consumer confidence all falling short of expectations, the prospects for a near-term Fed rate hike have progressively dwindled.

With this backdrop, Fed-watchers will be closely honed-in on any language that could imply the possibility of a June rate hike. Currently, while the Fed Fund futures market has priced-in only a 2% probability of a rate hike today, the current probability of a June hike stands at over 20%. Of course, this probability could change markedly based upon what comes out of Wednesday’s FOMC statement.

The possibility still exists, however, that the Fed could present some hawkish surprises that could jolt the financial markets. This could especially be the case since market expectations are so heavily skewed towards the dovish side. If this turns out to be the case, a volatile move is likely to occur, especially with respect to the US dollar, dollar-denominated commodities like gold and silver, as well as the major US equity indices.

The primary currency markets to watch today with respect to the afternoon’s Fed decision include USD/JPY and NZD/USD, as the Fed statement will also be followed by policy statements from the Reserve Bank of New Zealand and the Bank of Japan, both of which have the potential to present significantly market-moving decisions.

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