US dollar frozen as market remains divided over size of Fed's initial rate cut

The US dollar is under pressure as markets remain divided over the extent of the Fed’s interest rate cut.
Traders will wait on their hands until the decision is announced, followed by a press conference by Federal Reserve Chairman Powell.
The U.S. dollar index is recovering losses on Wednesday after a slight rebound the previous day.

The U.S. dollar (USD) is retreating and trading below 101.00, as measured by the U.S. Dollar Index (DXY), ahead of the U.S. Federal Reserve (Fed) interest rate decision on Wednesday. The DXY is under pressure near yearly lows and faces a key moment as the Federal Open Market Committee (FOMC) looks set to address the question of how much the Fed needs to cut interest rates. In addition to Fed Chairman Jerome Powell’s speech and press conference, the focus will be on the Summary of Economic Projections (SEP), or the Fed’s dot plot or Phillips curve, where each FOMC member has a chance to communicate where they think Fed interest rates are headed in the near future. The number of rate cuts they predict could be key in guiding markets in their expectations.

On the economic front, some relatively frail data points shouldn’t affect the Fed’s decision on Wednesday. Markets are still split between a 25-basis-point or 50-basis-point rate cut, so Fed Chairman Jerome Powell’s hints during his speech could shed a very different lightweight on the matter and could result in a knee-jerk reaction.

Daily Market Factors Review: Data Did Nothing

The main set of economic data on Wednesday was monthly building permits and housing starts. Monthly building permits rose to 1.475 million in August from 1.406 million in July. Monthly housing starts beat estimates at 1.356 million in August from 1.238 million earlier.
At 18:00 GMT, the Federal Reserve will release its interest rate decision, monetary policy statement and summary of economic outlook.
At 18:30 GMT, Federal Reserve Chairman Jerome Powell will take the stage to deliver a statement, followed by a question-and-answer session.
Asian stocks closed higher on Wednesday. European stocks are slightly less confident about the Fed and are trading with diminutive losses. U.S. futures are flat ahead of the open.
The CME Fedwatch tool shows that it will be very close this Wednesday, with a 37.0% probability of a 25 basis point (bp) rate cut. Meanwhile, the probability of a 50bp cut is 63%. Another 25bp cut (if there is a 25bp cut this Wednesday) is expected at the November 7 meeting (22.4%), while there is a 51.6% probability of rates being 75bp (25bp + 50bp) and a 26.0% probability of rates being 100 (25bp + 75bp) basis points lower from current levels.
The benchmark 10-year U.S. Treasury rate is 3.68%, rebounding from a 15-month low of 3.60%.

Economic indicator

Fed’s interest rate decision

This Federal Reserve (The Fed) considers monetary policy and decides on interest rates at eight scheduled meetings a year. It has two missions: to keep inflation at 2% and to maintain full employment. Its primary tool for achieving this goal is to set interest rates—both the rates at which it lends to banks and the rates at which banks lend to each other. If it decides to raise rates, the U.S. dollar (USD) tends to strengthen as it attracts more foreign capital inflows. If it lowers rates, it tends to weaken the USD as capital flows to countries offering higher yields. If rates remain unchanged, attention turns to the tone of the Federal Open Market Committee (FOMC) statement and whether it is hawkish (expecting higher future interest rates) or dovish (expecting lower future rates).

US Dollar Index Technical Analysis: Coin Flip

The U.S. Dollar Index (DXY) is expected to either stay in its range for an extended period of time or finally break out of the trough it has been stuck in for nearly a month. The Fed’s interest rate decision on Wednesday is a catalyst that has markets looking to finally break out of a bit of a consolidation phase. Given the divided views on the size of the rate cut, there is a risk that a knee-jerk reaction could end with the DXY opening Thursday still in the same tight range between 100.62 and 101.90.

The top of the recent range is 101.90. Further up, a acute 1.2% rally would be needed for the index to reach 103.18, with the 55-day uncomplicated moving average (SMA) at 102.82. The next tranche up is very hazy, with the 200-day SMA at 103.80 and the 100-day SMA at 103.84, just before the massive round level at 104.00.

On the downside, 100.62 (Dec 28, 2023 low) holds powerful and has already caused DXY to bounce twice in recent weeks. If broken, the next level to watch is the Jul 14, 2023 low at 99.58. If that level gives way, early 2023 levels would be around 97.73.

US Dollar Index: Daily Chart