Markets currently price in a 68% probability that the Federal Reserve will leave interest rates unchanged, compared with a 32% chance of a rate hike. This is the narrowest gap since September 2024, making a surprise outcome quite possible. How will the US dollar react? Let’s discuss this topic and make a trading plan for EUR/USD.
The article covers the following subjects:
Major Takeaways
- The US dollar has diverged from oil prices.
- Speculation about a Fed rate hike is intensifying.
- A passive Fed stance would weigh on the greenback.
- Keeping rates unchanged would support adding to EUR/USD long positions.
Fundamental Forecast for the Dollar Today
In previous Fed meetings, markets generally had a clear idea of the outcome. This time is different. CME derivatives imply roughly a one-in-three chance of a rate hike. The probability of tighter monetary policy climbed to nearly 40% a day before the meeting as tensions in the Middle East eased and oil prices declined. However, Iran’s subsequent strikes on US bases in Jordan and the rally in Brent crude reduced expectations of Fed tightening and sent EUR/USD sharply higher. These seemingly illogical moves illustrate just how nervous investors have become.
The US dollar has become less correlated with oil prices as a growing number of banks and investment firms have started expecting tighter monetary policy in July. According to Citadel Securities, a Fed rate hike would halt further inflationary pressures while also reinforcing the central bank’s independence. Wrightson ICAP sees no compelling reason for the Fed to refrain from raising rates, while PGIM believes the futures market is underestimating the likelihood of tighter monetary policy, even though those odds are already at their highest since September 2024.
Changes in Market Expectations for the Fed’s Interest Rate
Source: Bloomberg.
Nevertheless, the most likely outcome is that the Federal Reserve will leave the federal funds rate unchanged. Such a decision would be consistent with the Fed’s data-dependent approach, as the latest employment data disappointed while inflation has continued to ease. It would also reinforce confidence in FOMC officials, who have consistently argued that the current policy stance is appropriate. It would also spare the Fed from White House pressure. Donald Trump had repeatedly criticized former Fed Chair Jerome Powell for refusing to cut rates. How would it look if the candidate appointed by Trump were to raise them instead?
Ahead of the announcement of the July FOMC meeting results, the US president stated that Kevin Warsh would like to do the right thing, but that the Fed Chair needs a consensus to act.
According to TD Securities, if the Fed leaves rates unchanged and there are two or fewer dissenting votes, the US dollar will weaken significantly against the major currencies. That view makes sense, as speculators are holding the largest net long positions in the greenback since 2015. Unwinding those positions would provide fresh momentum for the EUR/USD rally.
U.S. Dollar Speculative Positioning
Source: Bloomberg.
The sharp swings in the major currency pair resemble the price action seen a week ago. Back then, the euro rallied on expectations of a hawkish ECB message but started to decline even before the Governing Council meeting. A similar pattern is unfolding now: traders first bought the US dollar and then began selling it without waiting for the Fed’s decision.
Trading Plan for EUR/USD for Today
In my view, a Fed rate hike or more than two dissenting votes within the FOMC would create an opportunity to sell EUR/USD. Conversely, if the Fed delivers the outcome currently expected by the market, it would support adding to long positions opened near the lower boundary of the 1.1370–1.1470 trading range.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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