Will the Federal Reserve raise interest rates today?

Risk sentiment was buffeted in both directions on Tuesday, leading to a relatively volatile trading day for most currencies.

The feeling towards the ongoing war in Ukraine appears to be one of cautious optimism. Fighting continues to rage on in the major cities, with air strikes leading to loss of life and considerable damage to residential areas. Talks on a possible ceasefire are, however, ongoing, with reports suggesting that significant progress has been made in the past few days. Ukrainian President Zelensky has also hinted at a compromise with Russia on NATO in the past 24 hours, saying yesterday that the country won’t be joining the organisation. This has raised hopes of a breakthrough in talks, but until we get concrete news of a ceasefire, the moves higher in risk currencies may be relatively contained.

Concerns surrounding further supply-chain disruptions have further weighed on sentiment in the past couple of days, with expectations for a hawkish message from the Federal Reserve keeping a lid on the recovery in emerging market currencies. Lockdowns have been widened across China as part of the country’s highly controversial ‘zero-covid’ strategy, with the entire Jilin province and technology hub Shenzhen under severe restrictions. This not only sent the Chinese yuan to a three-month low on Tuesday, but it has also dragged a number of the country’s neighbouring currencies lower as well, including the likes of the South Korean won, which is now trading at its lowest level since March 2020.

What to expect from the Federal Reserve later today

The Federal Reserve will be the main event later today, with the FOMC all but certain to raise interest rates by at least 25 basis points at 6pm GMT. Prior to Russia’s invasion of Ukraine, we had pencilled in a 50 basis point hike from the Fed at this month’s meeting. Developments in the past few weeks have, however, tempered our expectations somewhat, and we see anything more than a 25 basis point move as unlikely. With the market firmly in agreement, we expect the reaction in the US dollar following the meeting to be driven largely by the Fed’s communications on inflation and its accompanying macroeconomic and interest rate projections.

The Fed’s revised ‘dot plot’ will be key. We expect the ‘dot plot’ to show members expect at least five interest rate increases in 2022 (up from three in December), with rhetoric that would open the door to an even more aggressive pace of hikes should conditions warrant. Anything less than that would likely be perceived as bearish for the US dollar, while six or more hikes would be seen as bullish, and would likely trigger an immediate sharp move higher in the greenback. In its macroeconomic projections, we expect an upward revision to inflation and a modest downward revision to growth.

Chair Powell’s comments during his press conference will, as always, also be closely watched by market participants. While Powell won’t pre-commit to hikes at specific meetings on Wednesday, we do expect him to leave the door firmly open to an aggressive pace of hikes during the remainder of the year. We think it is too soon for Powell to outline a specific target date for quantitative tightening to begin, although an indication that this could be on the way at some point in Q2 may trigger a bout of dollar strength. Ultimately, however, the bar for a hawkish surprise is rather high and the dollar is already trading at rather lofty levels - near May 2020 highs against its major peers. This may limit gains in the currency, even in the event of a hawkish surprise from the FOMC.

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