FX Spotlight | Taper talk turns the USD | Article – HSBC VisionGo

Taper talk turns the USD
Finance  ·    ·  6 mins read

  • The USD did not react initially to the updated dot plot that points to three rate hikes in both 2023 and 2024…
  • …but Fed Chair Powell said criteria for a taper had been “all but met” in the press conference, supporting the USD
  • In our view, as the Fed’s policy normalisation process continues, the USD will gradually strengthen into 2022

At the 21-22 September Federal Open Market Committee (FOMC) meeting, the Federal Reserve (Fed) decided unanimously to maintain the target range for its benchmark policy rate at 0-0.25% and to continue to purchase US Treasuries and mortgage-backed securities at a pace of USD120bn per month. The focus was the updated “dot plot” (i.e., interest rate projections, but the projections are not a policy commitment rather they reflect the personal views of policy makers) and tapering details. 

The USD did not react initially to the updated dot plot that points to three rate hikes in both 2023 and 2024

Before Fed Chair Jerome Powell’s press conference began, our initial reaction to the September FOMC meeting cited a surprising lack of positive reaction by the USD to the updated dot plot. The median of 2022 interest rate projections may not quite have pencilled in a rate hike, but the 2023 and newly introduced 2024 projections pointed to a Fed ready to raise rates three times in both years. The 2024 median interest rate projection at 1.75% was higher than market pricing ahead of the FOMC meeting. However, neither the rates market, nor the FX market responded initially. Perhaps this was because the market expected Fed Chair Powell to downplay the significance of the 2024 projections, or stress that the interest rate projections generally reflect a collective judgement rather than a promise of future action. Alternatively, the market may have felt that the Fed would not, in the end, deliver the pace of tightening outlined in their dot plot.

The hawkish tone, with Fed Chair Powell suggesting that the criteria for tapering asset purchases had been “all but met”, support the USD

This surprising initial inertia in the USD changed during Fed Chair Powell’s press conference. Interestingly, the catalyst was not a discussion of the dot plot, but instead the Chair’s perspective on the case for starting tapering. The message, even from the often dovish Fed Chair Powell, is that the conditions for starting the taper process are “all but met (Bloomberg, 23 September 2021). It means kick-off for the taper process is now more likely to be at the 2-3 November FOMC meeting, rather than the 14-15 December meeting. It lent a hawkish tone to proceedings and likely forced the market to revisit its earlier indifference to the elevated dot plot.

Central bank divergence may see the USD strengthening gradually

The September FOMC meeting may have offered only a small step towards the exit, but it was a step nonetheless in the Fed’s gradual, well-flagged path that will see it pare back its policy accommodation and ultimately raise rates. Contrast this with the European Central Bank (ECB), for example, where rate hikes are an even more distant prospect, and guidance and inflation projections suggests the central bank’s bond buying will continue into 2024.

Our economists expect a November announcement of an eight-month tapering process that concludes in June 2022 

Our economists now expect the FOMC to announce its tapering programme in November, finishing in mid-2022. The September FOMC announcement may not rate as a decisive step along the exit path in the way 15-16 June’s FOMC was viewed by the market, but the exit process continues and our view is that the USD will gradually strengthen into 2022 as it has just done in the wake of Chair Powell’s press conference.

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