Wednesday, June 10, 2020

Will the Fed share the market’s optimism at its upcoming monetary policy meeting?

Tags
  • Dollar
  • Federal Reserve

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Analysts’ Pick: Will the Fed share the market’s optimism at its upcoming monetary policy meeting?

  • The greenback may slightly strengthen temporarily following the Fed’s monetary policy decision later tonight.
  • It is unlikely that the Fed will make any changes its current monetary policy tools
  • Last week’s better-than-expected unemployment data does not change the fact that the US is experience its poorest labour market on record.
  • Dot plot projections from the Fed is likely to indicate that most Fed officials share the consensus that the current low interest rate environment will go on for an extended period of time.
  • Improved sentiment on the global economy is likely to continue to put continued downward pressure on the Dollar Index in the short-term.

Traders are likely to focus on the Fed's outlook for the US economy as well as more details regarding its lending programs at the central bank's monetary policy decision at 2am (GMT +8) in the early hours of Thursday. Unlikely to happen is the Fed being overly optimistic on its outlook for the US economy, despite better-than-expected employment data for May.

Unemployment continues to remain at record high levels despite dropping more than expected in May

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While the month of May saw jobs being added to the overall US economy, the unemployment rate in the US still remains higher than any other crisis, even topping that of the Great Depression of 10.8% by almost three percentage points. But a recovery from April suggests that the Fed will likely reiterate the need for more fiscal stimulus from the US government, while also emphasising on its lending programs that is designed to meet the needs of the US economy.

In addition, negative rates are unlikely to be seen once again, and the market should have already priced this in. Fed Fund futures confirm this sentiment, implying that only a 1.1% probability for a rate cut is priced into the market for today's meeting while a 0.1% implied probability for a rate cut is priced in by the end of 2020.

Fed fund futures suggests that negative interest rates are no longer being priced into the market

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Easing in Covid-19 infections should also suggest that the Fed is likely to start to shift its emphasis back to economic data for decision making. Employment and inflation will be expected to remain low, especially as oil prices and demand for transport remains negatively impacted by the Covid-19 pandemic. Instead, the Fed may use more higher frequency economic data such as the weekly jobless claims data to continue to monitor the US economy.

Expectations for low inflation and high unemployment rates is likely to weigh on the outlook for the US economy for an extended period of time

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Dot plot projections will likely also be closely watched for signals regarding sentiment between Fed officials. Most economists surveyed by Bloomberg expect projections from the central bank to signal that rates will only be raised in 2022, while some believe that a rate hike will only be in 2023. In essence, a rate hike should not be expected anytime soon. However, we also expect Fed Chair Jerome Powell to downplay this projection, and reiterate that high amounts of uncertainty imply that the projections are highly flexible and subject to changes.

This meeting’s dot plot projections will likely show a strong consensus among Fed officials to keep rates unchanged for 2020 and 2021

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Hence, with economic data and uncertainty mostly skewing the outlook for the US economy towards the downside, the Fed’s outlook may put some upside pressure on the dollar. Powell's speech following the decision should also provide some reality check for market participants on the outlook for the US economy, especially after a strong rally seen in equity markets over the past week.

On Friday, consumer sentiment may provide some downside for the greenback however, as sentiment is most likely to have improved from May, likely thanks to easing lockdown restrictions across multiple states, including heavily impacted states such as New York. Sentiment may however, face some negative impact from the ongoing protests in states, although it should not outweigh the reopening of the economy since the extent of the demonstrations across the country varies with each state. Hence, the dollar may face downward pressure moving into Friday, as improving consumer sentiment, despite remaining at low levels, is likely to help boost investor's outlook for consumer spending in the US as the economy recovers.

Benefit claims data signal that while layoffs has eased, the rate of rehiring may be slowing as businesses start to feel the pressure of reduced consumer spending

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Our outlook for the Dollar Index remains skewed to the downside as result. While the Fed's upcoming monetary policy decision is likely to result in little change, its caution on high levels of uncertainty may provide some upside for the greenback, possibly lifting the dollar temporarily towards 96.62's level. But as risk aversion continues to ease in financial markets and as investors continue to price in the unprecedented levels of stimulus in the US, the Dollar Index is likely to face downward pressure following the decision. Friday's consumer sentiment looks likely to also help put pressure on the greenback, possible dragging on the Dollar Index past 95.86 along the week and closer towards 95.32’s level. Multiple risks that could put upside pressure on the dollar may unexpectedly surface however, including a renewal in US-China tension as well as the ongoing protest possibly accelerating new cases of Covid-19 infections.

Technical Analysis:

DXY

The dollar is facing strong downward momentum following multiple rallies in the stock market thanks to better-than-expected economic data over the past week. Fundamentally, as risk aversion continues to ease in the market, the greenback is likely to continue to fall. But with RSI signalling that the Dollar Index is approaching oversold levels, the greenback may have some room for some upside later today. The Fed’s monetary policy decision may facilitate some upside for the index, since it is likely to be cautiously optimistic and reiterate its call for the need for more fiscal spending as well as the high levels of uncertainty surrounding the US economy. This may be able to push DXY back towards the 23.6% Fibonacci retracement level, but is unlikely to break that resistance since market sentiment is likely still skewed towards a more optimistic outlook for the global economy as compared to the past few weeks. Hence, the bears look likely to be able to test the support at 95.86’s level and possibly break it, although it is unlikely to break the 0% Fibonacci retracement level due to the amount of downside risks for the global economy, which stems from the possible renewal of US-China tensions, and a potential rise in Covid-19 infections.

Support: 95.68 / 95.32 / 94.65

Resistance: 96.62 / 97.08 / 97.58

DXY Chart (H4)

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