Markets anticipate no policy change from the Federal Reserve, shifting focus to Chair Powell’s tone and press conference. As previous statements described the economy as “solid” amid a Q1 GDP contraction of 0.3%, markets will keenly observe any softening in language, indicating a potential dovish tilt.

The jobs market remains sound, with April’s payrolls increasing by 177,000, surpassing expectations, reinforcing the Fed’s current assessment. Despite a modest 10 basis point shift in the 2-year EU-US rate spread favouring the USD, the EUR/USD exchange has risen nearly 5%, reflecting that rate differentials aren’t currently steering FX movements.

Economic Uncertainty Overshadows Fed Talks

Economic uncertainty and weak sentiment are the predominant market drivers, overshadowing potential benefits from any hawkish rhetoric by Powell. Concerns around the weakening economy and ongoing trade tensions maintain the US dollar at a disadvantage.

Considering these developments, hopes for a dollar surge following the FOMC meeting might be unsubstantiated. Even with a hawkish stance from Powell, prevailing economic challenges and expectations for Federal Reserve easing contribute to continued risks of USD weakness.

From the pre-meeting pricing, it’s evident markets have largely ruled out any shift in Fed policy this month. The emphasis, then, will turn to the language used by Powell during the press conference. Previously, he described the economy as “solid,” despite data showing a small contraction in first-quarter GDP. That inconsistency now leaves room for interpretation: should he soften that tone, it may be understood as a signal that monetary easing is on the table sooner than later.

The employment figures certainly complicate matters for policymakers. With payrolls rising by 177,000 in April — a figure that beat forecasts — we can see why inflation-fighting remains on the Fed’s agenda. Still, the labour market’s stubborn strength appears increasingly at odds with other macro data flashing warning signs. Retail sales are stalling, credit conditions are tightening, and certain regional indicators are retreating. Such a mixed message demands careful analysis of Powell’s phrasing, especially around risks to growth and the inflation outlook.

On the FX side, the rise in EUR/USD — up nearly 5% despite the near-term advantage in US-European rate spreads — makes one point plainly clear: yield differentials are being ignored for now. It’s not that they no longer matter, but rather that broader forces are overriding them. Risk appetite, business sentiment, and geopolitical concerns are exerting a stronger pull than usual.

Dollar’s Role During Uncertainty

The dollar, in this context, has lost its conventional role as a haven during uncertainty. Weak productivity figures and persistent softness in PMIs have reduced confidence that growth can rebound sharply in the second half. Moreover, trade indicators continue to show strain, particularly from reduced export orders and supply-side interruptions. This puts further weight on Powell’s shoulders to calm nerves without sounding overly cautious.

For us, the old assumption that aggressive guidance or tough talk from the Fed will send the dollar higher feels misplaced right now. Market participants seem more attuned to indications of fragility in the real economy than to any reinforcement of past rate hikes. So even if Powell leans towards highlighting inflation persistence or points to readiness for further tightening, those statements may not carry the same influence they would have six months ago.

Under these conditions, short-term moves in rates may not provide direction for currencies. Positioning remains extremely sensitive to sentiment headlines and any forward-looking indicators that suggest cracks widening across key sectors. We’re watching consumer expectations data and small business confidence readings much more closely than usual.

What we’re dealing with is a decoupling between traditional monetary inputs and their effects in financial markets. Rate pricing and economic surprises are no longer in sync. That’s giving much greater weight to qualitative assessments of momentum in activity and spending. Powell’s remarks, therefore, will be scrutinised more for what they imply about future flexibility than any tough policy line.

Derivatives traders would do well to pay attention to the volatility term structure at the front of the curve. There’s a clear mispricing building as realised vol continues its decline while implieds remain sticky. This disconnect reflects just how unsure the market is about the next catalyst. Positioning across FX options suggests some expect a move, but there’s little agreement on direction. We believe that leaves room for sharp recalibrations depending on which narrative gains traction in post-Powell trading.

There is no shortage of uncertainty in pricing economic risk right now. That environment makes consistency in messaging from central banks more valuable than ever — but also harder to achieve. Watching Powell thread that needle, while keeping markets from sliding further into pessimism, will be no small task. How he balances this will likely matter more for near-term volatility than any reference to terminal rates or dot plots.

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