Investors are Nervous Ahead of the Fed Meeting

Exchange rates are changing chaotically this week with the U.S. Dollar index (DXY) is losing 0.2% with the mixed trading of the Greenback. The American currency has weakened against the Euro by a marginal 0.2%, standing at 1.07880. Its performance against the British Pound and Canadian Dollar remains relatively unchanged, while experiencing a 0.4-0.5% decrease against the Australian and New Zealand Dollar. Conversely, the Greenback has strengthened against the Yen by over 0.5%.

These erratic movements could be attributed to the nervousness ahead of the Federal Reserve’s (Fed) meeting on Wednesday. The robust U.S. labor market report for November tempered bullish expectations among stock investors. The report revealed a drop in unemployment to 3.7% from 3.9%, Nonfarm Payrolls rising to 199,999, surpassing expectations of 180,000. Even average hourly earnings edged up by 0.4% MoM, compared to the consensus of 0.3%.

The CME FedWatch Tool indicated a decrease in bets on a 0.25% rates cut by the Fed in March to 42.0% from 43.2% on Monday, a logical response to a resilient labor market and enduring inflationary risks. However, the following day saw these bets surge to 47.4%, seemingly without any clear reason. The U.S. debt market remained mostly unchanged, with benchmark 10-year Treasuries yields hovering around 4.20%. In contrast, the S&P 500 broad market index enjoyed a 0.5% rally, reaching 4632 points, the highest since March 29, 2022.

Investors appear to have adopted an optimistic outlook due to the rising S&P 500 index. Otherwise, there are few major explanations for this, as there are fewer reasons for the Fed to cut interest rates amid a resilient American economy. It is plausible that we are witnessing a classic bullish trap, wherein significant players manipulate exchange rates in one direction to maximize profits after the Fed decision is released.

However, capital flows into the ETF WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) do not align with this narrative. The ETF experienced its largest capital outflows in the last 10 weeks despite a stronger U.S. labor market. Such substantial exits confirm the increasing likelihood of Fed Fund rate cuts in March. Consequently, investors believe in a stock market rally and a weakening of the Greenback.

The technical picture does not currently support the idea of a weakening Greenback. Instead, the U.S. Dollar is following an ascending formation. Nevertheless, signs of the dollar running out of steam have emerged in the last 10 days. Technical opportunities for a weaker Dollar may materialize in the second half of the week, potentially allowing the EURUSD to rise towards 1.08500-1.08800 or even higher, reaching 1.10170.