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In our preview for the US Federal Reserve meeting on Wednesday, we look at the impact of a likely rate hike, the size of it, and what hikes are hinted at for the rest of the year. Aside from this, we also take into account the already strong USD and weak stock market due to the situation in Ukraine and how we feel this will feed into the decisions from the Fed.

A hike all but guaranteed

We think that there will a 25bps hike from the US Fed this week, marking a change in monetary policy. The reduction in balance sheet purchases will be completed, with the next logical stage being raising interest rates. This is needed to stem the high inflation (currently running above 7%) that exists in the US at the moment. Traditionally, higher interest rates helps to keep a lid on demand and spending, as consumers get rewarded more for saving rather than spending.

After the bumper inflation print from February, there was chatter about the Fed raising rates by 50bps. However, we think that this is unlikely, given the situation since then with the invasion of Ukraine. The soaring commodity prices, which we wrote about here, are already going to cause US consumers a headache. Therefore, we think that the committee will recognize this and only raise by 25bps.

The important outlook

We feel that the main thing to watch out for is the expectation of future interest rate hikes, and the accompanying reasoning for this. If we rewind to January, some large banks were calling for as many as six rate hikes this year alone! How much of this is still valid? Will the commodity prices and the tension in the East cause the Fed to materially shift their expectations for 2022?

Currently, we think the market consensus is with us for a 25bps hike. Therefore, confirmation of this probably won’t see a large move in the USD or NASDAQ as a result.

A 50bps hike will likely see the USD knee jerk stronger. Yet the outlook is going to be the key for the direction of the greenback.

It’s important to remember that the US Dollar index (DXY), is already at highs, and so the room to strengthen more is limited in our view. When we look at the bigger picture, we think that the situation in Ukraine is a larger mover than the actions of the Fed in the short term.

For stocks, it’s the reverse. The NASDAQ and S&P are already at lows, and so a 50bps hike would likely push the indices down further. But with value investors likely buying any dip, room for sustained downside just from the Fed raising rates looks unlikely in our opinion.

Ideas from here

Given our view, we would actually look to stay neutral on new trades going into the meeting. If anything, we would prefer to be short USD and long NASDAQ depending on what gets announced. A pushback on future hikes we think is likely, and if this is combined by some positive news out regarding negotiations in Ukraine, then we think that US stocks could rally.

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