The US dollar index (DXY) pulled back slightly in the overnight session as investors waited for the upcoming interest rate decision. The index is trading at $95.90, which is a few points below this week’s high of $96.20.
US economy growing
The Federal Open Market Committee (FOMC) will conclude its two-day meeting on Wednesday this week.
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The meeting comes at a time when the US economy is doing relatively well even as signs of a slowdown emerge.
Data published this week showed that the American consumer price index (CPI) rose to a 42-week high of 7.0% in December. That was the highest it has been in more than 40 years. And there are signs that the real inflation rate is higher than that.
Additional data showed that the country’s unemployment rate declined to a pandemic-era low of 3.9% in December. That was a better number than what analysts were expecting.
Meanwhile, data published last week showed that building permits, housing starts, and existing home sales jumped sharply in December.
However, there are risks to the economy. For example, the flash manufacturing and services PMI numbers published this week showed that the economy is slowing. This slowdown was attributed to the ongoing Omicron crisis.
Fed decision preview
Therefore, the US dollar index will react to the latest interest rate decision by the Federal Reserve. The bank is expected to leave interest rates unchanged. However, last meeting’s dot plot and the overall performance of the bond market show that the bank will hint at higher rates in the coming months.
The Fed will likely hint that it will hike interest rates in the March meeting and then end the quantitative easing policy in the same period.
Other central banks have turned hawkish as well. In December, the Bank of England made its first rate hike. And on Wednesday, the Bank of Canada is expected to also hike interest rates.
In theory, a hawkish Fed should be positive for the US dollar index. However, this is not guaranteed considering that the statement has already been priced in. Also, it should not come as a surprise when the Fed sounds a bit dovish.
Therefore, there is a likelihood that the DXY index will have a pullback after the Federal Reserve interest rate decision on Wednesday.
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