USD to change course of action ahead of Fed FOMC

Admittedly, the surprising spike up to 10% in repo rates due to a mismatch in borrowing and lending needs have put the Fed’s dovish bias at odds. Yet the inadequacy between the Fed easing and current USD appreciation against major currencies is not expected to last. Additionally, although the greenback plays the role of safe haven in the US – China trade dispute, minister-level talks are not occurring before October, thus questioning the uptrend. During the meeting, the Fed should justify its second rate cut of 0.25 percentage point on the Fed Funds Rate by highlighting the dragging trade war, the global growth outlook and the recent decline in inflation data. In this context, a stronger emphasis on a weakening economy and a more expansionary monetary policy would worsen the USD perspective, despite solid labor market conditions. Meanwhile, a lower dot-plot path, including only two rate decreases, should play in favor of the dollar.

As the Fed is about to deliver its second rate cut this year, questions arises over the Fed’s capability to ensure stable money market conditions. The intervention from Tuesday, first seen since 2008, consisting of repo auction worth a total of $53 billion and planned to increase by an additional $75 billion today in order to stabilize repo rates and bring the effective Fed Funds Rate to its middle target band, confirms that the Fed balance sheet should swell further thanks to Treasury purchases looking forward. Accordingly, the Fed should maintain a dovish bias, albeit the priced-in scenario of three rate cuts for 2019 might be challenged strongly following the meeting. On the same line, the demand for gold should strengthen while USD momentum is about to weaken sharply.

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