The Fed intends to lower interest rates for the first time after the crisis, the regulator is preparing the markets for this event in July. There are two main reasons for this: weak inflation and tensions in world trade. While the markets are arguing about the rate of rate cuts, Fed officials look at what is happening in different ways. Consider the four scenarios of the Fed’s decision and the dollar’s reaction.
1) One-time rate reduction — USD up
If the Fed reduces the rate as insurance and does not take any further steps, the dollar will grow. This scenario is most likely, given the latest economic data. The dollar is likely to rise in all directions with a noticeable rise against the euro, which is vulnerable after the ECB opened the door to a new stimulus. The pound will also suffer, but this scenario will not affect the yen, perhaps there will be a slight drop.
2) Reduce and “open the door” — USD down
The Fed can “open the door” to further lower rates — adhering to market expectations — without taking any concrete steps. Powell, citing growing uncertainty, may announce new moves this year. In this scenario, which has an average probability, the dollar is likely to fall, but not critically, in the end, the markets expect further cuts. The depreciation of the dollar will be uniform in all directions.
3) Reduction by 50 bp — the fall of the USD
To calm the markets, Powell can choose a shock reduction of 50 basis points. Even if he says that no further action is expected, a significant rate cut is likely to have a serious negative impact on the dollar. This scenario is unlikely, as the Fed values its reputation. In this scenario, commodity currencies such as the Canadian and Australian dollars may be on the wave due to increased risk appetite, which may cover the stock markets. In this case, a safe haven will lose ground.
4) There will be no reduction — USD growth
Another low-probability scenario. Recent optimistic data will force the Fed to hold its position and only “open the door” to lower rates in September. In this scenario, the dollar will grow rapidly. Its chances are extremely small, as it contradicts a clear signal to the markets, but this cannot be ruled out. Commodity currencies could suffer from a massive sell-off along with the euro and the pound. The yen and possibly the Swiss franc may surpass the US dollar.