Dollar boosted by Fed’s shift in tone | Calamatta Cuschieri

Markets summary

The euro to US dollar (USD) exchange rate has moved in two to three month-cycles since the end of 2020.  The eurozone currency was trading at the 1.23 handle against the US at the start of 2021, culminating two months of positive performance and starting the year at a two-and-a-half year high.

The pair fell steadily across the first quarter of 2021, hitting a year-to-date intraday low of 1.1703 on 31 March and registering a drop of 4.4% over the 3-month period. The euro weakened, and the USD performance improved across this period as the US ramped up its vaccination drive whilst the eurozone struggled under its second lockdown and experienced a slow start to its vaccine programe.

From the start of the second quarter, the euro was rising again versus the USD, rebounding off 1.17 before running into resistance at 1.2270 on 1 June.  Rising risk appetite dragged on the USD, boosting the euro doing this period.

Since the start of June, the US dollar has started to strengthen again amid growing divergences in the direction of monetary policy between the European Central Bank (ECB) and the Federal Reserve (Fed). 

Whilst the ECB remained firmly accommodative in the June meeting, the Fed adopted an unexpected hawkish stance, bringing forward the anticipated timing of the first post-pandemic interest rate rise.  It also took the opportunity to upgrade the growth outlook to 7% during 2021 and raising its inflation forecast to 3% for 2021 and 2.1% for 2022.  The median Fed forecast now expects two interest rates rises in 2023.  Perhaps even more surprisingly, seven out of the 17 policymakers suggested interest rates would rise as soon as 2022.

An uneventful July Fed meeting saw the USD losing some traction at the end of the month  as the Fed made it clear that it was in no hurry to tighten policy, meaning that they were not planning to raise interest rates anytime soon.

Nonetheless, following the unexpected shift by the Fed to two interest rates rises in 2023, the outlook for the USD dollar has improved and US dollar predictions have turned more upbeat.  A stronger that expected jobs report last Friday rekindled dollar momentum which was further supported in the middle of the week by statements from the Vice Chairman of the Federal Reserve who suggested that conditions for hiking interest rates might be met as soon as late 2022.

August is setting up as a potentially pivotal month for the US currency ahead of the Fed’s late summer symposium of global central bankers.  The Fed will host its global counterparties in Jackson Hole, a venue that in the past has been used to announce coming policy changes.  A hawkish message for the Fed that signal it could taper stimulus in the months ahead could add fuel to the dollar’s summer surge.

 

Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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