The US dollar has been on fire since last Thursday, extending gains one day after an unexpected shift in the Federal Reserve’s inflation and interest-rate outlook, and raising doubts about the earlier consensus view for a weaker currency in 2021.
A stronger US dollar in the coming months were based on the view that the debate about inflation and Fed policy would heighten in the approach to the Fed’s Jackson Hole symposium. The surprise from Fed’s shift was perhaps the most pronounced in the currency markets, reflecting expectations even among analysts, who had been sceptical of calls for dollar weakness. They previously believed that the Fed would continue to play down inflation fears and put off the discussion of eventual tapering at the June policy gathering.
The FOMC meeting lifted the dollar, which is not surprising, given the Fed’s new median forecasted two rate hikes in 2023. However, a key point to note is that this could still leave it behind, or not very far in front of many other central banks, including Norway’s Norges Bank, the Bank of Canada, the Reserve Bank of New Zealand and the Bank of England.
Furthermore, President James Bullard, Federal Reserve Bank of St. Louis, said the economy is seeing more inflation than he and his Federal Reserve colleagues anticipated only a few months ago, and that he now expects to see a central bank rate increase next year.
Mr. Bullard said that when he submitted forecasts at last week’s Federal Open Market Committee (FOMC) meeting, he put the first move up from near-zero short-term interest rates currently to start in late 2022. Ahead of the FOMC meeting, Mr. Bullard had said that he was not ready to call for a shift in monetary policy while the coronavirus pandemic was still a major force for the economy.
At the meeting, Fed officials opened the door to the option of paring some of the massive stimulus they have been providing the economy during the pandemic. Officials projected a stronger economic outlook with notably more inflation this year. While they all still agree no rate increase will happen this year, they moved to pencil in increases through 2023, compared to the March forecasts with no projected increases. Officials now believe the Fed will lift rates twice by 2023.
Mr. Powell started a debate last Wednesday, about the Fed reducing its bond-buying stimulus. The Fed is currently buying $80 billion a month in Treasury bonds and $40 billion a month in mortgage bonds to smoothen the markets and provide stimulus beyond its near-zero short-term rate target. The taper discussion is open, and the Powell made that very clear. However, it is going to take several meetings to get organised on all these different points.