• Dollar gains ahead of tomorrow’s Fed decision
• Spain’s inflation accelerates for the first time in six months
• Euro/dollar could slide, but outlook stays positive
• Treasury yields rise, weighing on Wall Street

The US dollar traded higher against all the other major currencies on Monday and continued to gain ground against most of them today as well.

With no major data releases or events to drive the greenback yesterday, it seems that traders may be liquidating some of their short positions ahead of tomorrow’s FOMC decision. The Committee is broadly expected to hike by 25bps, with several officials lately admitting that such a slowdown seems appropriate.

However, with most of them sticking to their guns that interest rates should rise to above 5% and stay there for a prolonged period thereafter, the message in the accompanying statement and Fed Chair Powell’s press conference may have a hawkish flavor.

Although market participants and the Fed agree on the size of tomorrow’s hike, what happens thereafter is a bone of contention, with the market expecting a peak slightly below 5%, and nearly two quarter-point cuts by the end of the year.

Therefore, a hawkish message could allow the dollar to gain a bit more. That said, recent history has shown that market participants are willing to sell dollars aggressively when data enhances their pivot view, but they are not buying with the same excitement when economic releases surprise to the upside. So, the dollar is unlikely to skyrocket, and an overly hawkish ECB on Thursday, confirming expectations of more 50bps rate increments beyond February, could also limit any dollar strength, as euro/dollar is by far the largest component of the dollar index.

European equities came under selling pressure and closed in the red after data showed that Spain’s inflation accelerated for the first time in six months, adding credence to the view that more double hikes are in store for the upcoming ECB gatherings. Other data showing that the German economy unexpectedly contracted in Q4 may have also weighed, but with the January preliminary PMIs suggesting that the Euro area economy as a whole returned to growth, such concerns are likely to soon fade.

Yes, the Eurozone economy could still slip into a much-predicted recession, but it is likely to be milder than originally feared. Ergo, combined with another acceleration in the euro area’s underlying inflation on Wednesday, this is likely to keep expectations of a hawkish ECB elevated and thereby allow the euro to continue drifting north.

Even if euro/dollar corrects lower this week due to a hawkish Fed and a relatively decent employment report, the slide may be seen as offering a renewed buying opportunity, with a potential rebound setting the stage for a test at 1.1175 in the foreseeable future. For the pair’s latest uptrend to come into question, the ECB may need to sound more dovish than expected on Thursday.

Alongside the US dollar, Treasury yields rose as well, resulting in a red day on Wall Street. All three of its main indices slid, with the more rate-sensitive Nasdaq falling almost 2%. It seems that market participants are already pricing in a hawkish message by Fed Chair Powell and his colleagues, but with both the Nasdaq and the S&P 500 currently trading above their prior downtrend lines, figuring out what are investors’ longer-term plans remains a mystery.

Maybe earnings by tech-giants Apple, Alphabet and Amazon on Thursday can clear some of the fog, but with aggregate earnings for S&P 500 now expected to fall 3%, even if the absolute result still seems bad, anything pointing to a smaller decline could allow for some further recovery.

Having said all that though, further deterioration in the US data is unlikely to allow a recovery to last very long, as a deeply wounded economy is anything but encouraging for firms and their future earnings. For the S&P 500, the territory where the bulls could surrender may be at around 4150.