FX Spotlight | FOMC: USD goes dotty | Article – HSBC VisionGo
- The USD rallied markedly on the shift in the FOMC median dot, which now shows two 25bp rate hikes by the end of 2023
- Fed Chair Powell said a discussion about tapering had commenced, but no specifics on timing or structure were given
- In our view, USD bullish reaction is justifiable but not necessarily sustainable
The technical adjustment is to alleviate the excess USD liquidity conditions, in our view
The Federal Open Market Committee (FOMC) voted unanimously (11 to 0) at its 15-16 June meeting to hold the federal funds target range steady at 0-0.25%. However, two administered rates were lifted: the interest rate on reserve balances (IORB) was increased to 15bp from 10bp, and the rate on the Fed’s overnight reverse repo facility (ON RRP) was increased to 5bp from 0bp. This technical adjustment should not be interpreted as a tightening of monetary policy, while this could alleviate the excess USD liquidity conditions, in our view.
FOMC median dot now shows two 25bp rate hikes by the end of 2023
The USD rallied markedly on the shift in the FOMC median dot for 2023 which now incorporates two projected 25b rate hikes from the current level. In addition, seven out of 18 participants now project a rate hike by the end of 2022 (up from four previously). While an upward shift in the dot plot was expected by the consensus (Bloomberg survey released on 13 June), the expectation was that the 2023 revision would nudge the median higher by a 25bp step rather than 50bp. The USD rally reflex is understandable. The question is whether it is sustainable?
There were few other surprises. The core PCE deflator is a measure of inflation based on changes in personal consumption and is closely monitored by the Fed. The FOMC lifted the inflation forecast for Q4 2021 substantially higher to 3.0% from its projection of 2.2% made in March, while the forecast for Q4 2022 was nudged only from 2.0% to 2.1%. This shows that the Fed remains confident that the current upswing in inflation will prove transitory, an expectation repeated in a largely unchanged accompanying statement.
The Fed signals an overall tone of patience, challenging the initial USD bullish reaction to the higher dots profile
The USD rally did not accelerate during the Federal Reserve (Fed) Chair Jerome Powell’s press conference, but nor did it reverse. Some of Powell's observations in isolation might have been a challenge to the initial USD bullish reaction to the higher dots profile. He noted that the FOMC has not even had a discussion on the timing of the first rate hike. He also added that dots are not a great forecaster of future rate moves and that they should be taken “with a big grain of salt”. Instead, he noted that the focus is on when best to start tapering and, while progress towards the two goals of price stability and maximum sustainable employment is being made, he observed that the “substantial further progress” had yet to be met. The Fed will continue to discuss the degree of progress being made at upcoming meetings, signalling an overall tone of patience.
Fed Chair Powell said that a discussion about tapering had commenced, though no specifics on timing or structure were given
That the USD did not give up its earlier gains in response to these observations may reflect the potency of the dots in driving the FX market’s reaction. In addition, while Chair Powell downplayed the dots in terms of their forecasting power, he observed that they are consistent with the economic projections, which suggest more participants are comfortable that substantial progress towards their goals may come sooner than previously envisaged. Finally, he said this is the meeting where policymakers did talk about talking about the taper. This is another step towards eventual policy normalisation.
We still expect some additional modest USD weakness in the months ahead
We have argued that the Fed's patient approach to policy leaves the door open to some additional modest USD weakness in the months ahead. The tone of the Fed at the June FOMC continues to emphasise a patient response. We have also noted that the drivers to the USD are likely to undergo a transition as the Fed moves towards policy normalisation, a transition that may put a floor under the USD. However, we are not convinced that this transition point has been reached in full and a still-patient Fed may frustrate the more hawkish elements of the market. The reflex strength of the USD to the higher-than-expected dots projection is understandable, but this FOMC meeting was an iteration rather than a revolution.
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