Fed will determine the dollar's further fate (Daily analysis 17.03.2021)

The stability of global investment sentiment can be largely linked to the anticipation of today's Federal Reserve meeting. It is far too early to rule out further nervousness in bond markets, which would hurt the emerging economies' currencies and support the dollar.

The dollar still keeps its charm

Since the beginning of the year, the dollar has been supported by a relatively good economic situation. The pace of the rebound will be additionally accelerated under the influence of the gigantic fiscal package approved last week. Faster vaccination progress than, for example, in the European Union, better epidemic situation and gradual unfreezing of economic activity in subsequent states are also important. This combination suggests that the world's largest economy will grow by as much as 7 percent this year (a similar scenario is assumed, among others, by OECD forecasts).

As a result, there are many voices saying that inflation may get out of control, which would force the Federal Reserve to cut off the monetary stimulus sooner, i.e. to start slowing down the asset purchase programme, which is currently conducted at the pace of at least 120 billion USD per month. Such a view translates into a bond sell-off, which is the largest in eight years and is becoming the dominant trend, continuously dictating the direction of stock, commodity and currency markets.

Federal Reserve will set the course for the dollar

Further developments will depend mainly on the outcome of today's Federal Reserve meeting (7:00 p.m. CET). Mantra-like declarations that the monetary authorities will wait patiently before changing the interest rate are not enough to calm the unstable debt market, but Jerome Powell did not seize the last chance at the beginning of the month to announce that in March tools to stop the growth of debt yields would be announced. Certainly, we should expect a sharp revision of the economic growth forecasts for this year - the GDP growth forecast for December at 4.2 percent is far from the already quoted OECD estimates or market consensus.

Fed representatives' prevailing rhetoric means that policymakers should not significantly raise their expectations for the inflation path. However, the most important factor will be the projections of the optimal level of interest rates. If there are more voices saying that the cost of money should be raised in 2023, they may be interpreted as preparing for the reduction of the pace of asset purchases and become grist for further sell-offs of bonds and the strength of the dollar. For the time being, however, FOMC representatives should continue to be characterized by cautious optimism. Nuances will define the outcome of the meeting, including an assessment of the impact of the bond market reshuffle on the economic outlook. The real test will be whether the Federal Reserve will change its tone at the June meeting. Then, the effects of generous social transfers, which are the foundation of Joe Biden's aid programme, will be visible to the naked eye, and the risk of overheating the economy will be better assessed.

US economy in temporary trouble

If one were to look only at the data released yesterday, such a threat might seem unrealistic. Industrial production and retail sales both contracted compared to January. Both of these disappointing readings can be largely attributed to one-off factors, including the attack of the harsh winter. Consumption slowed down for a moment primarily as the effect of the previous fiscal package on household spending weakened. The first Americans have already received their 1,400 USD checks, consumer sentiment is excellent, and there are no signs that the pandemic will leave a mark on spending. Despite a sharp decline in February, retail sales are higher than they were before the pandemic struck - consumption will remain the engine of an economy that retains a very good outlook.