EUR/USD, USD/JPY key levels heading into ISM, employment, FOMC

The significance of today’s FOMC meeting has continued to grow, as incoming US economic data has continued to surprise to the upside. And with that, expectations of any rate cuts this year have been crushed – which is impressive when you consider markets were pricing in five or more cuts just three months ago.

If we take a look at the implied yield for the Fed fund futures December 2024 contract, it has risen from the January low of 3.75% to 5.1% yesterday. Which means market pricing has effectively erased 5.4 hypothetical 25bp cuts. And as my colleague David Scutt tweeted earlier, “Fed funds curve now has less than a hike priced this year”.

Personally, I was never on board with the multitude of hikes being priced in and thought two cuts to be more realistic. But even that was beginning to appear tight assuming the Fed do not want to cut to close to the election. Yet we’re now in May, inflation, wages, labour costs are higher and employment remains firm, I’m having trouble seeing a single cut and now think talk of a hike may not be that crazy. The question is whether they’d feel inclined to drop any such hints today.

My base case is that the Fed will acknowledge strong economy and pour cold water on that final cut markets are trying to price in. They're not going to mention a hike, even if they're sat there wondering if they may need to later this year. But the thought has surely crossed their minds. 

However, if Powell plays into the hands of doves and keeps the door open for a cut, it could boost sentiment for equities, commodities FX and weigh on the US dollar.

Economic events (GMT+1)

US data will be closely watched ahead of the Fed meeting, in hopes that it broadly softens and allows Powel to keep the door open for a cut. By some estimates, the Flash manufacturing PMI is expected to contract for the first time this year, which could carry some more weight if it backed up by a softer ISM report and both have lower ‘prices paid’ indices. And a surprisingly weak ADP employment report could also help. But I am not holding my breath, given US data is generally surprising to the upside and the Citi FX inflation surprise index is hovering around its highest 18-month high.

• 13:15 – US ADP nonfarm payroll report
• 13:15 – Canada’s manufacturing PMI, BOC Macklem speaks
• 14:45 – US final manufacturing PMI (S&P Global)
• 15:00 – US ISM manufacturing, JOLT job openings, construction spending
• 19:00 – Fed interest rate decision, FOMC statement
• 19:30 – FOMC press conference

EUR/USD technical analysis:

The daily chart on the left shows that a prominent bearish outside day formed on Tuesday, to take momentum back in line with the downtrend. I had warned of the potential for US dollar strength on Monday, and bulls clearly delivered. From here I suspect a retest of the April low and break beneath it, given the diverging policies between the Fed and ECB – of which the Fed already have the higher interest rate. The question now is how it might get there.

Clearly today’s Fed meeting is a risk event so bullish and bearish outcomes should be considered. If the Fed meeting does little to change its tune, then there is risks of a USD retracement (bullish EUR/USD) on the assumption the dollar could hand back some of Tuesday’s pre-emptive bets of a more hawkish Fed. If so, I would prefer to seek evidence of a swing high, of which several appear below the 1.07 handle.

USD/JPY technical analysis:

We’ve seen USD/JPY move higher towards the 158 as expected, although we didn’t get the pullback towards 156 / Monday’s open as I had hoped. For now, it appears that price action is simply filling the liquidity gap left when the BOJ intervened around 159.59.

The resistance cluster around 158 could provide pivotal; a break above could see prices accelerate higher towards 159 as prices try and fill in the remainder of the intervention liquidity gap. Yet I remain unconvinced that USD/JPY will simply break above 160 given the +400 pip decline that occurred last time that level was tested. Therefore, bears could seek evidence of a swing high around the 158 for an anticipate US dollar pullback, or wait to see if one forms up to the 159 handle on the assumption that USD/JPY will not dare to head for 160 just yet. 157, 156.30 and 155.50 area downside targets currently in focus. 

-- Written by Matt Simpson

Follow Matt on Twitter @cLeverEdge