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Last night’s Fed meeting turned out to be a bit of a non-event in the end, at least as far as financial market is concerned, as suggested by the lack of volatility. US equity and bond markets are not much changed this Thursday from Wednesday’s pre-FOMC levels, though admittedly the dollar is substantially weaker, for reasons that will be discussed below. For now, the meeting. What went down?
As expected, no major changes were made to the Fed key monetary policy tools, with the federal funds rate held at 0.0-0.25% and the pace of QE buying left at $120B per month ($80B in US treasuries and $40B in mortgage-backed securities or MBS). Two notable changes were made to the FOMC’s new statement on monetary policy, however; the first was the addition of a line stating that the economy had made progress towards its dual mandate goals, although the Fed did not say that “substantial” progress towards these goals had yet been met, which is the condition the bank has said is required for it to begin tapering its asset purchase programme. Meanwhile, the bank’s view on the sectors worst affected by the pandemic was upgraded to having “shown improvement but have not fully recovered” from “remain weak” (in the last statement). So the statement has become incrementally more hawkish to reflect continued progress in the US economic recovery, but this seems to have been in line with market expectations.
In terms of Powell’s remarks in the press conference; he stuck to his usual line about the Fed thinking that the current spike in inflation is going to be transitory. On the labour market, he said that there is still “ways to go” for the labour market to recover fully (as expected, given employment levels in the US right now are still about 6M below where they were before the start of the pandemic). He said there is still “some ground to cover” for “substantial” progress having been met towards the Fed’s employment goal (again, this is the condition the Fed wants to see to start tapering its asset purchase programme).
Separately, Powell played down concerns about the impact the current nationwide surge in Covid-19 delta variant infections will have on the economy, given high vaccination rates in the US that ought to keep Covid-19 related deaths and hospitalisation at “acceptable” levels. Meanwhile, Powell gave a few hints about his preference for the Fed’s sequencing of monetary policy tightening steps; he said it was likely that, when winding down QE purchases, treasury buying, and MBS buying would be reduced at an even pace and said that ideally the Fed would not raise rates prior to its QE taper having concluded. If the latter remains the Fed stance, the rate at which the bank opts to wind down its QE programme could thus be crucial in informing when the first-rate hike is coming.
Though there weren’t really any dovish vibes from last night’s FOMC meeting, the US dollar has come under pressure and the DXY briefly slipped to one-month lows under the 92.00 handle this morning. It appears that, with the FOMC out of the way with no major surprises, the USD has been given the green light by market participants to play catch up to the recent fall in US real yields to record lows. Note, in recent sessions, US real yields had been dropping, which is normally bearish for the dollar, but the dollar had been holding up, perhaps amid nerves that the FOMC might be more hawkish that expected and anyone selling USD due to falling real yields might be caught offside. As long as real yields remain at these subdued levels, the opportunity cost of holding USDs will remain high, undermining its investment appeal.
Also weighing on the dollar has been a further improvement in risk appetite in key international markets, which has been weighing on the dollar’s safe haven demand; Chinese stocks were supported overnight amid reports that Chinese regulators had met with banks to ease concerns about the recent crackdown on sectors like tech, education and overseas listings that had been weighing on stock prices there recently. The continued recovery in China-related sentiment has seen CNH surge for a second; USDCNH is back in the 6.46s having been as nearly as high as 6.53 on Tuesday. Meanwhile, strong earnings in Europe have helped to propel major bourses there higher and the Stoxx 600 to a fresh record high above 462. All of this is hurting the dollar on Thursday but remember also that a few banks have been calling for month-end selling in the USD, another factor which might be exacerbating recent moves.
What next for Fed policy and the US dollar?
Last night’s FOMC meeting and press conference with Chairman Powell does not seem to have delivered a meaningful tweak to market expectations for Fed monetary policy, both with regards to when the bank will start tapering its asset purchases programme and regarding when the bank will begin hiking rates. Various banks have left their calls for the Fed to announce tapering sometime later this year unchanged (most are calling for the official announcement to come at the September, November or December policy meetings). Market participants will now look to the Jackson Hole global central banking event in late August for more clues from Powell as to when this taper will be announced. The timing of the taper announcement is of course not as important as the timing of the actual taper itself; most analysts suspect the Fed to begin tapering its QE purchases from the start of 2022 and are calling for it to take between six and 12 months for the Fed to fully unwind from its current $120B per month in purchases.
It shouldn’t matter too much for markets whether the Fed opts to announce a QE taper starting in January 2022 in September, November or December this year. Announcing that it will begin tapering its asset purchase programme sooner than that would be seen as hawkish, however, but is seen as unlikely by most. Meanwhile, money markets continue to price around a 25% chance that the Fed will lift the federal funds rate by 25bps by July 2022 and a 60% of an at least 25bps hike December 2022. This is relatively unchanged from prior to Wednesday’s FOMC meeting, suggesting markets still expect the FOMC’s hiking cycle to begin prior to what its current dot-plot guidance suggests (a majority on the FOMC still think rates will be at the zero lower bound through to 2023).
So what does this all mean for the dollar? The FOMC’s comparatively more hawkish monetary policy stance versus some of its key G10 counterparts (like the ECB, BoJ, SNB and even now RBA) had supported the dollar in the second half of June and throughout most of July. This comparatively more hawkish central bank advantage that the USD holds over the currencies of these central banks has not changed in wake of the latest Fed meeting. If anything, with the FOMC becoming incrementally more hawkish to reflect the progress being made by the US economy back towards its policy goals, this central bank divergence has only widened. That might suggest the USD ought to do well versus the likes of EUR, JPY and CHF, so some traders might be looking to “buy the dollar dip”. Persistently low US real yields are a big problem for the dollar though, and we may need to see a rally from record lows in the 10-year and 30-year TIPS yields to see any meaningful dollar recovery back towards monthly highs.
Meanwhile, with tapering still likely some months away, as long as risk appetite can hold up, the dollar is going to find it hard to gain against more risk-sensitive currencies in the G10 and EM space. Many of these currencies are also likely to be helped further against the dollar amid their comparatively more hawkish central banks; in the G10, the BoC (helping CAD), Norges Bank (helping NOK) and RBNZ (helping NZD) are all positioned well ahead of the Fed in terms of tightening monetary policy. In the EM space, many central banks are already hiking or are about to hike, like the BoK (helping KRW), CBR (helping RUB), BCB (helping BRL), Banxico (helping MXN), NHB (helping HUF) and CNB (helping CZK).
