Dollar to move higher amid risks and FOMC

Stocks and US equity futures fell Monday, hurt by a slump in Hong Kong property developers and jitters ahead of the Federal Reserve meeting that’s expected to hint at moving toward paring stimulus. This caused the dollar to rise.

Ten-year Treasury yields have risen ahead of the Fed meeting this week where policy makers are expected to start laying the groundwork for paring stimulus. Aside from Evergrande and the prospect of reduced Fed stimulus, financial markets also face risks from uncertainty over the outlook for President Joe Biden’s USD4 trillion economic agenda as well as the need to raise or suspend the US debt ceiling. Investors were already fretting over a slowing global recovery from the pandemic and inflation stoked by commodity prices.

When Federal Reserve Chairman Jay Powell gave his Jackson Hole speech three weeks ago, the US economic recovery seemed unstoppable. Strong job reports in June and July, combined with elevated inflation readings in those months, had convinced the majority of FOMC participants that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year,in Powell’s words.

But then a string of surprises followed, mostly negative: disappointing consumer spending and sentiment data; August job gains well below even the most pessimistic forecast; a hurricane that exacerbated supply shortages and energy prices; and activity data from China, the world’s second-largest economy, that showed alarming weakness. In addition, as the FOMC heads into its meeting next week, the US government will be a little more than a week away from running out of money to continue operations, with a funding bill still elusive.

We expect that the FOMC won’t be swayed by these inter-meeting developments, but will instead attribute the weakness to temporary factors while acknowledging downside risks from the pandemic and the fiscal standoff. The statement likely will communicate that inflation has met the criteria of “substantial progress” toward the Fed’s price objective and the labour market is expected to have made substantial improvement by the end of the year, two markers for the central bank to begin tightening policy.

Most importantly, the September statement likely will be the first time since the pandemic began that the FOMC includes language about plans to reduce asset purchases this year “if the economy evolved broadly as anticipated.” Though details on any potential tapering will be kept light and open-ended, we expect the inclusion of such language will satisfy the aim, as noted in minutes of the Fed’s June meeting, to set the stage “well in advance” for a formal taper announcement, which we expect at the FOMC’s November meeting.