Will Dollar rise or fall on FOMC?

The Federal Reserve holds their first 2021 FOMC meeting on Wednesday and based on the performance of US assets, investors don’t expect any surprises from the central bank. The rally in stocks and broad based decline in the US dollar are signs that investors are looking for steady policy. That means continued commitment to accommodation accompanied by an upbeat outlook for the second half recovery.  Its no secret that December was tough – the US reported its first month of job losses since April, consumer spending dropped for the third month in a row and jobless claims spiked higher. New virus cases surged across the nation, forcing many states to bring back restrictions but none of that sapped investor optimism because ongoing vaccine rollout has made everyone more confident about a second half recovery. 

Going into the January policy meeting, the question of whether the dollar is a buy or a sell hinges on two things – Fed Chair Powell’s recovery outlook and comments on tapering. Over the past month, a number of Fed Presidents suggested that tapering could begin as early as late 2021 if the recovery is strong enough.  If Powell admits to sharing this sentiment, USD/JPY should soar past 104.00 and EUR/USD could break through 1.21.  

In December, Powell provided some important clues on where he stands. At the time, they dialed up their expectations for growth and refrained from extending the maturity of asset purchases, which was seen as slightly less dovish. Fed Chair Powell also said the economy should perform strongly in the second half of 2021 thanks to the vaccine but they would still need to continue buying bonds until there is substantial progress made on their goals. On tapering, he noted that they will give “ample warning” before tapering bond purchases.  

While more Americans are getting vaccinated every single day, stocks are near their record highs and Biden promises more stimulus, premature taper talk could derail the recovery. There’s no doubt that they’ll discuss this further but the year has just begun and Powell could wait another month or two before setting the stage for less stimulus. For all of these reasons we think that even if the US dollar rallies on Powell’s positive comments, if he doesn’t add fuel to taper talk, the rally should be seen as an opportunity to sell higher as the dollar will inevitably resume its slide. 

For the second day in a row, the New Zealand dollar was the best performing currency. In contrast to manufacturing, which contracted sharply in the month of December, the contraction in services eased with the PSI index rising to 49.2 from 46.7. Services led the decline in November and it could now be leading the recovery. We won’t know until next month but for, low virus cases, US dollar weakness and good data contributes to rally. The Australian and Canadian dollars also moved higher with AUD/USD likely to extend its gains if tonight’s report shows CPI growth quickening in the fourth quarter. 

GBP/USD closed in on 2.5 year highs following better than expected labor data. Thanks to the country’s furlough scheme, there were fewer job losses and strong wage growth. New virus cases are also beginning to fall, which is positive for the country’s prospects. With no data on tap euro lagged behind all of the major currencies.