Trading The Fed: USD Pullback Likely If The Fed Sounds Less Hawkish

This article originally appeared on FXStreet.

The FOMC rate decision is due at 18:00 GMT Wednesday. The central bank is expected to keep the rates unchanged. However, the markets are positioned for a hawkish Fed. For instance:

• The bearish bets in 10-year Treasury futures currently stand at record highs, according to United States Commodity Futures Trading Commission data.
• The dollar index (DXY) has appreciated by 3.74 percent since April 17.
• The probability that the Fed would hike rates three more times this year has almost doubled to 40 percent in the last few weeks.

Clearly, investors are expecting the Fed to sound hawkish - signal three more rate hikes this year and hint at a June rate hike. As Kathy Lien from BK Asset Management says the Fed would want to drop a hint today if it intends to hike rates in June.

The markets will likely read the June rate hike signal as a sign the Fed is ready to hike rates three more times this year.

The USD rally will likely continue if the Fed does signal a June rate hike. On the other hand, the treasury yields and the US dollar could lose altitude if the Fed stays neutral/sounds dovish. The market is extremely bearish on the treasury futures (bullish on the yields), hence the pullback could be ugly if the Fed disappoints market expectations.

USD/JPY: Close below 100-day MA would signal bullish invalidation

Daily chart

USD bulls appear to be in control as suggested by the higher lows and higher highs pattern and the ascending (bullish) 5-day MA and 10-day MA. So, the spot looks set to test 110.04 (61.8 percent Fibonacci retracement of Jan high-March low).

But the relative strength index (RSI) shows overbought conditions. So, the stage is set for a pullback to 109.00 - 108.77 (100-day MA) if the Fed sounds less hawkish than expected. Only a close below the 100-day MA would signal bullish invalidation.

A convincing move above the 200-day MA cannot be ruled out if the Fed signals June rate hike.

GBP/USD: Most vulnerable to central bank divergence

According to a Reuters report, "the odds of a Bank of England (BOE) hike later this month have faded to about 1-in-6 from 70 percent several weeks ago". No wonder, the GBP/USD has taken a beating (down 777 pips since April 17) and could drop even further if the Fed drops June rate hike hint.

Daily chart

As seen in the above chart, the GBP/USD breached the long-term ascending trendline, signaling a bull-to-bear trend change. The 5-day MA and the 10-day MA are trending south, indicating a bearish setup. So, the spot looks set to test the 200-day MA support of 1.3532. A further decline cannot be ruled out if the Fed sounds hawkish. Meanwhile, the oversold nature of the RSI would come into play if the Fed keeps three hikes in play.  

Gold: Drop below $1,300 likely

Daily chart

Repeated bull breakout failure, followed by bearish Bollinger band breakout and acceptance below the 200-day MA favors a drop below $1,300. Gold's daily RSI is yet to hit the oversold territory unlike the GBP/USD's RSI and USD/JPY's (overbought RSI). So, there is enough room for a drop below the psychological mark. Corrective rallies could run out of steam around the descending (bearish) 10-day MA, currently located at $1,320.