USD: FX reaction to be relatively contained next week – MUFG

The key event next week will be the FOMC meeting. Analysts at MUFG Bank, consider Fed Chair Jerome Powell is set to reiterate the gradual approach of QE tapering and on interest rate hikes.

Key Quotes:

“The US dollar strengthened notably yesterday with risk appetite weak fuelled by the ongoing concerns over the impact on growth from supply-constraints and the continued regulatory crackdown in China and renewed default concerns following the trading suspension of Evergrande bonds yesterday. The fragile risk conditions look to certainly be a validation of the caution communicated by Fed Chair Powell at Jackson Hole over the commencement of QE tapering. We expect Chair Powell to repeat that if the “economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year”.”

“Our FX correlation analysis confirms that the US dollar is becoming more sensitive to rate moves at the short-end of the curve. Short-term rates jumped in June after the FOMC meeting then saw the DOTs surprise to the upside. We don’t expect a repeat of that next week. A repeat of the June profile with a similar pace for 2024 as 2023 would be a relief to the market and likely see some modest USD depreciation. The DOTs confirming a median hike in 2022 would illicit the biggest FX reaction with DXY likely to trade back above the 93.000 level. A 2022 median DOT would clearly undermine Powell’s attempts to break any link between tapering and rate hikes.”

“Assuming a 2022 median rate hike is not revealed, we would expect FX reaction to be relatively contained next week.”