Dollar exchange rate insensitive to Fed signals (Daily analysis 23.09.2021)

The Federal Reserve is making further moves to exit crisis mode. However, this does not create much of an impression on investors. On the equity markets, the rebound continues; the EUR/USD pair stayed around 1.17.

Risk appetite evaporated in the first part of the week due to fears about the stability of the Chinese financial system. This is certainly not the end of the saga, in which the protagonist is the Chinese developer Evergrande, struggling with gigantic financial problems. However, so far, the lack of bad news is already good news.

Further steps towards normalisation

Later this year, US GDP will be higher than it would have been if there had been no pandemic and the economy had grown at a pace consistent with the trend of previous years. The strength of the economic rebound makes powerful central bank support less and less necessary. As a result, the tapering, i.e. reduction of the pace of crisis asset purchases in the amount of 120 billion USD, has been practically a foregone conclusion for a long time. Despite this, the Federal Reserve wants to wait with the announcement of the decision; it has not yet decided on such a step. However, it was explicitly announced that it is close, directly referencing the meeting scheduled for 2-3 November.

Why are decision-makers still waiting? The reason is that about 5 million of the more than 22 million jobs lost last year have yet to be recreated, and the latest report on the state of this sector of the economy was a harsh disappointment. The recent slowdown in the recovery is definitely due to problems with the availability of labour rather than a weak demand for labour - after all, a record number of vacancies exceeding 10 million has been recorded. Nevertheless, the monetary authorities want to see "further evident progress" before starting to put crisis tools aside.

Dollar relatively insensitive to support for hikes

The clues as to how it will proceed may prove to be more important than the timing of the tapering announcement itself. The actual cutting of the monetary stimulus will start in December, and initially, the reduction in tapering will probably be on the scale of 15 billion USD. At the same time, Jerome Powell has indicated that the whole process may end even in the first half of next year (in May, to be precise). This means that in such a scenario, the first possible date of interest rate increase comes closer - the end of 2022 comes back into play. This demonstrates an evolution in policy makers' perceptions of the nature of inflation: until now, it has been repeated like a mantra that it is temporary. Today, doubts as to whether this will happen are becoming evident, including at the Fed.

Such a conclusion can be drawn mainly from the updated projections, which are a mixture of the expectations of all members of the Open Market Operations Committee (i.e. not only those voting in a given year). The most important of these, concerning the optimal level of interest rates, present an evenly divided FOMC: equally half (i.e. nine) of the policymakers consider a hike next year as an appropriate step. Raising interest rates in 2022 was suggested by seven central bankers in the previous edition of forecasts. Inflation expectations have also risen: the most important measure of inflation is expected to grow by 3.7% this year and 2.3% next year (vs. 3.0 and 2.1% previously).

Traditionally, Jerome Powell has warned that it is a mistake to link steps taken in the field of asset purchases with intentions to raise interest rates. We may risk the thesis that while the labour market determines the end of quantitative easing, price processes in the world's largest economy will determine the timing and agility of increases. The meeting seems to confirm our thesis that the positive impact of US monetary policy on the dollar has been used up. The centre of gravity at the Fed has shifted closer to hikes next year, and the US currency has not been given a boost. It is no longer possible to accelerate the rise in the cost of money; delaying it is more than possible. In our opinion, the high bar of expectations will be a ballast for the dollar in the coming months: we expect the EUR/USD to drift towards 1.20 and a good environment for emerging market currencies.