The dollar index started the week on a rather pessimistic note, trading below 102 points, suggesting that the market is setting low expectations for a hawkish Fed outcome on Wednesday. A moderate correction is taking place in the risk assets as a reaction to a possible turbulence due to a series of central bank meetings this week. Major European indexes and futures for US indices are in the red on Monday. The price of gold, which has been a pretty good proxy for expectations for the Fed's interest rate path since the beginning of this year, is consolidating around $1925, also indicating relatively mild expectations for a dovish Fed surprise.

The dollar could come under pressure, with EUR/USD above 1.10 if the Fed makes a big surprise, in particular by saying that any additional rate hike after 25bp this week will depend on incoming data. However, the chance of such an outcome is low. It is more likely that the Fed will reject market expectations of a 50 basis point rate cut in the second half of the year, in which case the dollar will move into a short-term rally.

Potential EURUSD reaction following FOMC decision

In addition to the FOMC meeting on Wednesday, there are two important reports on the US economy on the US data calendar. First, the Fourth Quarter Labor Cost Indicator (ECI) is one of the Fed's preferred measures of price pressure in labor markets. This indicator rose to 1.4% in the first quarter of last year from the previous three months, but is expected to fall to 1.1% in the fourth quarter from 1.2% in the third. Any surprise upside here could see expectations shift towards a more hawkish FOMC decision. And on Friday, the US jobs report for January comes out.

Clearly this is a busy week for FX and perhaps most of the volatility will come from the results of Wednesday night's FOMC meeting and the ECB/BoE decision on Thursday. The opening of Chinese markets after the public holiday of the Lunar New Year should also add some volatility to Asian markets price action. Investors are very optimistic about China reopening its doors and will need more data this week to see if the potential recovery momentum in the Chinese economy remains. Tomorrow we will see the Chinese PMI for January, where a significant rebound is expected to support the bullish positions on Chinese risk assets.

The main view of the ECB meeting is that the central bank will remain hawkish and resist the 2024 easing. This should see EURUSD's 2-year swap differentials continue to narrow and be positive for EUR/USD. The narrowing of the swap differential is the main market factor in the EUR/USD appreciation.

Before the ECB meeting on Thursday, euro zone economic confidence figures for January will be published today. They are expected to improve slightly, but any upside surprises will fuel the hypothesis of lower energy consumption and strong fiscal stimulus to ensure recessions, if any, are mild.

A 50 basis point rate hike by the Bank of England could provide moderate support for the pound sterling. The base scenario for a 50 basis point upswing is not fully priced in by the market. And with wage pressures lingering and the impact of a low base not leading to a significant decline in the consumer price index until the second quarter, it looks like it's too early for the Bank of England to relax on the predictability of inflation. Depending on the state of the dollar after the FOMC meeting, by the end of the week GBP/USD may rise to 1.2500.