Oversold dollar struggles to rebound ahead of anticipated Fed decision

The US dollar has weakened substantially in recent weeks and months, mostly as a result of lowered expectations for higher interest rates from the Federal Reserve. As usual, the Fed has been giving mixed signals, but the latest market interpretation ahead of Wednesday’s FOMC decision has mostly been dovish. The Fed has appeared to shift the focus of its monetary policy normalization from rate hikes to balance sheet reduction, and the dimming prospect of higher interest rates has taken a serious toll on the dollar. In-line with this shift, the Fed is not expected to make any interest rate changes on Wednesday, but more details on its plan to begin shrinking its balance sheet are anticipated.

While the Fed’s recent dovish turn may indeed be a cause for concern for the dollar, especially as several other central banks embark on a hawkish shift towards policy tightening, the dollar’s virtual freefall against other currencies appears to have been overdone. Much of the Fed’s latest dovishness has already been priced-in to the weak and oversold dollar going into Wednesday’s FOMC announcement. Any surprises that may arise, therefore, will likely be to the hawkish side amid widespread dovish expectations.

For the USD/JPY currency pair, the past two weeks have seen the latest bearish leg push the unit below the key 112.00 support/resistance level once again. Only this week has USD/JPY begun to rebound, but heavy pressures on the dollar have made any recovery a struggle. If such a recovery is to take place, it will likely be driven by a Fed on Wednesday that may be perceived as less dovish than currently expected. In this event, the technical hurdle to overcome will be the key 112.00 level, a proverbial “line-in-the-sand” for USD/JPY. Any sustained breakout above 112.00 resistance could propel the currency pair back up towards a key resistance target around the 114.50 level.

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