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25.01.202123:42 Forex Analysis & Reviews: Should the dollar hope for support from the Fed?

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Exchange Rates 25.01.2021 analysis

The Federal Reserve will hold its first meeting this week, not only in a new year, but also with the new administration. The inauguration of the 46th president of the United States was held on January 20. No adjustment of monetary policy parameters is expected at this meeting, but traders will closely monitor the tone of the central bank's management, where it could provide signals for possible further actions.

Some analysts believe that the January meeting of the US central bank will be similar to the recent meeting of the European Central Bank. In other words, the Fed, like the ECB, will leave everything as it is and report on the risks that the pandemic generates. The difference is that the epidemiological situation in Europe is much worse than in America.

It is worth noting that the Fed meeting will take place during a certain legislative impasse. Congressmen have not yet decided what to do with the new stimulus project and the impeachment of former President Donald Trump. Nor is it entirely clear what the work of the new divided Senate will be.

From Fed Chairman Jerome Powell, investors expect to maintain a balance between the need for monetary stimulus and some optimism about the prospects for the economy against the background of mass vaccination. At the press conference, Powell will have to reassure investors of the stability of the Fed's policy and keep them hoping for an improvement in the economy.

Exchange Rates 25.01.2021 analysis

It is worth noting that this week the Senate will confirm Janet Yellen as the new head of the US Treasury. Presumably, the former head of the Fed knows which buttons to push in order to get the central bank to agree with the policy of the new administration. In her last speech, Yellen made it clear that she was concerned about the growing national debt. Main priority is to help Americans and businesses in the fight against the pandemic. She urged officials not to delay with incentives and to act on a large scale.

Recent confidence in the economic recovery has boosted treasury yields. Thus, borrowing for the Treasury has become more expensive. This year, America will have to place trillions of dollars, the first two need to be placed in the coming months.

The Fed is also interested in uncontrolled growth in government bond yields, although it remains independent of the government. At the moment, the US Fed prefers less strict control, targeting the total volume of purchases on the balance sheet and short-term rates. However, in other large countries (Japan and Australia), they apply control over the yield curve. It was also used in the last century, when the US national debt was at just as dangerously high levels and there was nowhere to cut rates.

The willingness to take such measures may be expressed in the comments at the upcoming meeting. It is unlikely that this will have any serious impact on the US dollar. At least the national currencies of Japan and Australia did not collapse after the introduction of similar measures in their countries.

Today, after the consolidation in the afternoon, the dollar index moved to growth. In the US session, it gained a symbolic 0.3%. The dollar's rebound is driven by a drop in risk appetite, with investors eyeing defensive assets.

Dollar traders are waiting for further signals from the Fed or the Treasury Department. It is unlikely that they will act ahead of the curve, thus driving the dollar far up or down. Most likely, they will take a wait-and-see attitude before an important event this week.

Exchange Rates 25.01.2021 analysis

As for the dollar's current growth, it comes at a time not only of growing yields, but also at a time of reduced risk appetite caused by increased uncertainty in US policy. Joe Biden has just taken office, and investors are already worried about his ability to pass a $1.9 trillion stimulus package and distribute 100 million doses of the vaccine in the first months of his presidency. Mass vaccination is not happening as quickly as originally planned, as the states are facing supply constraints. At the same time, Republican leaders oppose the new stimulus program and consider it doomed to failure. Without successful vaccination and an aggressive incentive package, it is known that a further rally of risky assets is impossible.

However, no one can predict a radical change in the trend or a steady movement up in the dollar. Speculators in the foreign exchange market remain extremely bearish to the US currency.

MUFG believes that it is too early for the dollar to hope for support from the central bank. Therefore, experts still bet on a further weakening of the dollar against a basket of competitors.

"The Fed may not begin to slow down the pace of quantitative easing purchases until next year. The process of reducing quantitative easing is likely to be a gradual process that may last through 2022," the analysts wrote.

Thus, the first rate increase will not occur until 2023.

Natalya Andreeva
Analytical expert of InstaForex
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