The highlight of the new trading week will be the FOMC meeting on Wednesday. The Federal Reserve is expected to leave monetary policy unchanged while again playing down the inflation threat. There are unlikely to be any surprises when it comes to the actual rate decision, but traders will be looking for hints whether the central bank is getting concerned about the uptick in inflation.
The Federal Reserve will keep its funds target rate unchanged at 0.00-0.25%, while maintaining its $120 billion monthly QE purchases intact. The focus will be on the latest forecasts.
The central bank has tried hard in the past few weeks to keep markets calm and stress that the inflationary pressures are only temporary. However, with the US economy close to running hot and recent CPI figures having exceeded the already high expectations, the pressure is growing.
Stock markets are trading at record highs but inflation fears are taking a toll on their performance, and sell-offs like we have seen in May could occur more frequently, with technology stocks hit the hardest. Traders will also keep a close eye on the bond market. The US 10-year yield has been consolidating following a rapid rise earlier this year, but remains at elevated levels.
Inflation is at a 13-year high and it will become increasingly difficult for the Fed to convince markets that there is nothing to worry about. The upcoming FOMC statement is likely to sound a bit more balanced and acknowledge rising inflation expectations.
The only card the Fed has left to play is the labor market. Recent jobs numbers have been disappointing and there is a case that low rates and significant support measures are still needed for it to recover from the pandemic.
Overall, the most likely outcome is that the Federal Reserve will revise their inflation forecasts to the upside, but refrain from taper talks, which may follow in autumn.
Should the Fed maintain its dovish stance by refraining from mentioning taper talks and emphasizing the weakness in the labor market, stock markets are likely to extend gains. The index to watch is USTECH, which has been lagging behind in recent weeks. Tech stocks would likely outperform in such a scenario, pushing the index beyond the current record high at 14,074 points.
At the same time, this would be negative for the US Dollar. XAU/USD could see a swift recovery in that case, as Gold is benefiting from the on-going inflation concerns and it has been the stronger Dollar that has been weighing on the metal recently.
On the other hand, should the Fed strike a more hawkish tone, tech stocks are likely to come under increased pressure, while the Greenback could extend recent gains. The US Dollar is likely to outperform the low-yielding currencies in such a scenario, which would make USD/JPY an interesting currency pair to watch. USD/JPY has been struggling to gain momentum recently, but the uptrend remains intact, and a hawkish Fed could push it towards 112.25 resistance.
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