Will They Won’t They?

The US Federal Reserve meets for its first FOMC review of 2021 today. There has been a great deal of speculation ahead of the meeting as to whether the bank will ease further given its potential to impact the US Dollar.

Factors to Consider

On the one hand, the economic situation with regard to the pandemic remains a key downside threat. The Fed was involved in a record amount of easing over 2020 which saw the Dollar selling off strongly. The change in US political leadership has also been a big factor for the Dollar. With the new administration looking to ramp up stimulus, growing the deficit, the downside risks for the Dollar are clear. However, in terms of more optimistic factors, the US is leading the pack in its vaccination effort, stock markets remain near record highs and the prospect of huge, new US fiscal stimulus takes some of the immediate pressure off the Fed.

Economic Situation

Despite some better data points over recent months, such as an uptick in inflation and the ongoing recovery in PMI readings, there are still some major issues. The December jobs report showed the US economy losing jobs for the first time since April last year along with consumer spending declining for a third consecutive month as a result of soaring virus numbers and increased lockdown and social restrictions returning.

While this would suggest the need for easing in the near term, the Fed appears more likely at this stage to await the outcome of the current US stimulus negotiations. With $900 billion in domestic aid having been agreed in December and with Biden pushing for a $1.9 trillion package, there is room for the Fed to wait before acting.

Vaccinations

Additionally, with the US currently vaccinating around 6 million citizens a week, having already vaccinated 20 million people so far, there is a great deal of optimism around the chances of defeating the virus this year. With this in mind, the Fed is likely to continue point to a rebound over the second half of 2021. Fed’s Powell, as well as several other members have affirmed this view over recent weeks. While the Fed is likely to acknowledge the current slump and near term threats, the H2 recovery message is still likely to be a key feature.

Impact on USD

In terms of assessing the impact on the US Dollar, the key will be how far the Fed goes in its outlook. Towards the end of last year we heard some Fed members discussing the possibility of easing being reduced into the second half of H2 as the recovery strengthens. If there is any further mention of this today this could easily send USD higher in the near term as traders start to scale back easing expectations. However, should the Fed simply reiterate its message that easing will remain in place as long as necessary with rates on hold until 2023, the impact on USD is likely to be muted.

Technical Views

DXY

The Dollar index continues to oscillate around the 90.50 level. Following the bounce off the 89.32 level support, the index is trading within the middle of the bear channel. Near term bias remains bearish for now though a break above 90.50 will turn attention to the 91.74 level and the channel top, a break of which could signal a bullish reversal for USD.

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