Dollar awaits Fed policy meeting as new scenarios are now on the table

The dollar index showed a mild reaction to the US inflation report, moving within a narrow range after data release, as many things remain unclear, in a fragile conditions, one week ahead of Fed’s policy meeting.

Initial expectations that the US central bank would accelerate its policy tightening again, due to stubbornly high inflation, were tempered by the SWB collapse and fears that the crisis could deepen, if more banks were hit by high interest rates.

Forecasts for possible increase to 0.5% rate hike were reduced to 25 basis points, which currently marks prevailing expectations, but new speculations started to circulate in the markets, suggesting that the central bank may opt for 25 basis points hike or keep the policy unchanged, but may also shock by cutting interest rates in the policy meeting next week.

The economic data released today shows that inflation remains elevated and requires further policy tightening, but fresh fears on stronger negative impact from a collapse of two banks, signal that the central bank now has limited space to maneuver.

Growing concerns that crisis in the financial sector may deepen, require and extra caution by the US central bank, fueling the latest speculations about possible decision to cut interest rates.

The dollar would likely come under increased pressure in the scenario of rate cut and would fell towards 100.66 (2023 low, posted on Feb 2), while unchanged policy would also keep the greenback at the back foot.

Conversely, the dollar would rise if Fed decides to raise interest rate by 25 basis points, though this is widely expected scenario, so the reaction may not be strong, while surprise decision for 50 basis points would lift the dollar.