- FOMC will release the minutes of the May policy meeting on Wednesday, May 25.
- Markets have already priced in two more 50 bps Fed rate hikes.
- Investors will pay close attention to discussions around the Fed's balance sheet reduction plan.
The greenback is having a hard time preserving its strength toward the end of May and the US Dollar Index (DXY) remains on track to post monthly losses for the first time in 2022. Following the US Federal Reserve’s decision to hike its policy rate by 50 basis points (bps) earlier in the month, policymakers have been voicing their willingness to raise the policy rate by a total of another 100 bps in the next two meetings.
Two more 50 bps Fed rate hikes a done deal
Markets seem to have already priced in those expectations with the CME Group FedWatch Tool pointing to a more-than-80% probability of the Fed hiking by 50 bps in June and July. Hence, the dollar is struggling to find demand as investors see the US central bank adopting a cautious stance moving forward. Renewed optimism about the annual Consumer Price Index (CPI) having peaked at 8.3% in April and the hawkish tilt in other major central banks’ policy outlook, especially the European Central Bank (ECB), play a part in the recent dollar weakness as well. Nevertheless, there is still a bit of room for a hawkish surprise in the FOMC’s May Meeting Minutes.
Eyes on details surrounding QT
In the May policy statement, the FOMC announced that it will begin trimming its balance sheet on June 1, starting with a $47.5 billion cap on monthly runoff and rising to $95 billion monthly after three months. As it currently stands, the Fed is on track to execute a monthly reduction of $60 billion in Treasury securities and $35 billion of mortgage-backed securities each month from September.
The meeting minutes could offer additional details on the Fed’s quantitative tightening plan. When the Fed decided to raise the policy rate in 2017, the prepayment rate on MBS, which represents the ratio of borrowers paying the principal on their mortgages ahead of schedule, declined significantly. Jefferies economist Aneta Markowska thinks that if the prepayment rate were to fall to 10% from about 30%, as witnessed in the previous tightening cycle, MBS outflows could average about $20 billion a month. In such a scenario, the Fed would have to start selling MBS to reach the monthly reduction target of $95 billion.
While speaking at an event last week, New York Federal Reserve President John Williams said that their forecasts suggested that they won’t be able to reach the $35 billion monthly target for MBS redemptions and added that selling MBS could be an option down the road. The issue with MBS sales, however, is that they could translate into losses for the Fed. "A potential drawback of sales is that, depending on the interest rate path, they could result in realized market-to-market losses," Cleveland Federal Reserve President Loretta Mester said earlier in the month. Mester acknowledged that it would be a difficult problem to solve, especially at the political level.
In case the Fed’s publication shows that policymakers are willing to sell MBS to stay on the monthly QT target of $95 billion regardless of the potential political pushback, this could be seen as a hawkish development and help the greenback start outperforming its rivals.
On the other hand, the dollar could extend its downward correction if the minutes don’t offer any fresh insight into the Fed’s QT plan and reaffirm that policymakers remain reluctant to commit further policy moves after two more 50 basis points rate hikes.
Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers. The author will not be held responsible for information that is found at the end of links posted on this page.
If not otherwise explicitly mentioned in the body of the article, at the time of writing, the author has no position in any stock mentioned in this article and no business relationship with any company mentioned. The author has not received compensation for writing this article, other than from FXStreet.
FXStreet and the author do not provide personalized recommendations. The author makes no representations as to the accuracy, completeness, or suitability of this information. FXStreet and the author will not be liable for any errors, omissions or any losses, injuries or damages arising from this information and its display or use. Errors and omissions excepted.
The author and FXStreet are not registered investment advisors and nothing in this article is intended to be investment advice.
Follow us on Telegram
Stay updated of all the news
AUD/USD recovers to 0.6700 amid upbeat mood
AUD/USD is battling 0.6700, recovering losses induced by softer Australian monthly inflation data. The US Dollar is struggling to extend the rebound amid a better market mood, as the global banking jitters ease. Focus on US data, Fedspeak.
USD/JPY approaches 132.00 amid BoJ-speak, firmer yields
USD/JPY is holding higher ground, approaching the 132.00 level early Wednesday. The pair is capitalizing on the risk-on mood and higher US Treasury bond yields amid mixed comments from the BoJ policymakers. US housing data next on tap.
Gold to extend choppy trading, awaiting a fresh catalyst Premium
Gold price has paused the previous rebound early Wednesday, as the United States Dollar (USD) seems to have found its feet following a rough start to the week. However, the underlying strength in the US Treasury bond yields so far this week could limit the Gold price advance.
This is how Arbitrum and Optimism are dragging users away from Ethereum
Arbitrum became the highlight of the month as the Layer-2 (L2) blockchain launched its native token, ARB. Since then, the L2 narrative that was once the talking point of 2022 has exploded again.
Unfazed: Confidence edges higher despite banking situation
Consumers may not love the present conditions, but a slightly more upbeat take on where things are headed was enough to give overall confidence a nudge in the right direction in March.