Wednesday, July 29, 2020

The Fed may sound more dovish at its upcoming monetary policy decision, but is there room for the dollar to fall more?

  • Dollar
  • Federal Reserve


Analysts’ Pick: The Fed may sound more dovish at its upcoming monetary policy decision, but is there room for the dollar to fall more?

  • Fed’s monetary policy decision should result in little surprise, investors should instead focus on Powell’s words in his press conference.
  • More explicit forward guidance may be due, or at least an update on it as the US economy stagnates on its progress for an economic recovery
  • A more dovish statement looks increasingly likely as well, to help support sentiment in the US.
  • The Fed’s monetary policy decision may have some downward pressure on the dollar, but other fundamental issues looks likely to be the key driver for the greenback in the short-term.

The Fed looks set to keep monetary policy on hold at its decision on monetary policy at 2am (GMT +8) on Thursday. But the focus should instead be on the central bank's statement and Fed Chair Jerome Powell’s post-meeting press conference. Meeting-to-meeting, the Covid-19 and economic situation in the US has not fared better than expected in the Fed's last monetary policy discussion and instead is looking possibly worse-than-expected. There has been a resurgence in multiple states which have prompted the reintroduction of state-specific lockdowns. States that have reimplemented some form of restrictions include California, Texas and Florida, which are the top three states in the US by population. While this puts the Fed in a position to possibly do more on the monetary policy front, we do not expect much material changes to the current policy since the resurgence of the virus was already a prominent risk leading up to the previous meeting, especially so as there were large gatherings of people to protest in the US during the period.

Market Expectations for a rate cut remain understandably low


Spikes in new Covid-19 cases in several large states came after the Fed’s last meeting on June 10th


This has impacted the economic recovery in the US as well and looks likely to have longer lasting effects on consumer spending than previously thought. More up to-date-data has signalled that there may be some weakness in July and possibly in August; consumer confidence has dipped while jobless benefit claims suggest that the US may be experiencing another wave of unemployment. This would also imply that Fed policymakers are more likely to revise down their forecasts for the rest of the year and remain more conservative, although this week's meeting is not scheduled to have quarterly forecasts.

Weakness in July’s consumer confidence index from the US conference board was driven by weaker sentiment for the US’ economic outlook


Initial jobless claims spiked above the four-week moving average line for the week ended July 17th, breaking the 15-week long down trend


But with the overall US economy showing signs of improvements in certain areas and sectors, it is unlikely that the Fed will be forced to act. Consumer spending should now come to the forefront of concern, thanks to the stagnation in decline of overall jobless benefits claims and spike in people claiming benefits for the first time. Weak consumer expectations and the expiring unemployment insurance as part of the CARES Act (which provides eligible Americans an additional US$600 a week on top of the existing jobless benefits) on Friday, July 31st.

Monthly data signals an imbalance in an economic recovery in the US


Hence, this suggests that the Fed Chair Jerome Powell is likely to reiterate his general call for additional fiscal support to help the US economy's recovery. In addition, there may also be more explicit forward guidance, or at least an update on it, regarding the central bank's rates at today's meeting instead of later this year since higher frequency data indicates that consumer spending is set to decline again. This assumption is also further reinforced by Powell's urgency in deploying monetary policy since the onset of the pandemic. An explicit forward guidance would give the central bank's current tools more firepower, in terms of effectiveness by driving inflation expectations and hence real interest rates lower which in turn reduces long-term borrowing costs.

The dollar may as a result experience some more downside pressure in addition the current downward momentum it is experiencing due to the shift in positions towards the euro, Japanese yen and gold. This is mainly due to the increased likelihood that the Fed will be more dovish-than-expected relative to before. The Dollar Index as a result looks like to retest the June 2018 lows at 93.20's level and possible break it to trade close below 93.00. A key risk for the Dollar Index is that its currently trading at oversold levels (Daily), which is considerably rare for the greenback since 2018, suggesting that a rebound may be due soon.

Technical Analysis:


Greenback bears have managed to pull the dollar into a downtrend for the ninth week and with no signs of stopping. With the current momentum, the Dollar Index looks likely to test the low last seen in June 2018. The bears may be able to break that level with the Fed’s help as it looks more likely that policymakers will skew the central bank’s statement more dovish than before as the US continues its battle against the Covid-19 pandemic. However, as the Dollar Index is trading in oversold levels in both the four-hourly and daily price movements, there may be room for the index to retest the 38.2% Fibonacci retracement level at 94.19. But it appears that a correction may only be short-lived, given that fundamentals appear to tilt favour away from the dollar and towards other assets such as gold, euro and the Japanese yen instead.

Support: 93.20 / 92.54 / 91.92

Resistance:  93.85 / 94.46 / 95.67

DXY Chart (H4)