US Dollar – 3 Things to Watch for in June FOMC

The US dollar traded lower against all of the European currencies on Tuesday ahead of the Federal Reserve’s monetary policy announcement. Investors took profits on risk trades as the Dow Jones Industrial Average closed lower for the first time in 8 trading days. We’ve had a very strong rally in stocks and high beta currencies over the past few weeks and with such a major event risk ahead, profit taking is not unusual. The US dollar will be in focus tomorrow but there’s very little consistency in its performance today. The greenback traded lower against the Japanese Yen and Swiss Franc but moved higher against other major currencies. However that should change tomorrow as the FX market is driven by US dollar flows. Based on the latest price action, investors do not expect much from the Fed. They are not expected to change interest rates or increase Quantitative Easing but FOMC should still be a big mover for currencies and equities.

These are the 3 things investors should watch for on Wednesday:

1. INTEREST RATE DOT PLOT – One of the most important aspects of the June FOMC will be the central bank’s interest rate projections or dot plot. The last time the dot plot was released was in December because the March meeting was canceled. At the time, policymakers expected interest rates to remain unchanged until 2021. Of course rates were much higher then than they are now, so at bare minimum all interest rate projection levels will be notched lower. However the big question is how long do policymakers expect rates to remain at new lows? There’s no doubt that it will be throughout 2021 but they may not look for rates to increase until the end of 2022. The longer the duration to tightening, the more negative the impact on bond yields and the US dollar.

2. ECONOMIC PROJECTIONS – Its also been 6 months since the Fed’s last economic projections were released. On Monday, the National Bureau of Economic Research confirmed that the US economy fell into recession in February. Their projections for 2020 growth will be ugly but investors are prepared for that. Instead, they’ll be focused on how long before a meaningful recovery. While the following table below show broad based deterioration in the US economy since the April meeting, more recent measures particularly the jobs and manufacturing reports have shown consistent improvements. The US economy is on the road to recovery but will it take 9 to 12 months or 2 to 3 years? The faster the recovery, the better it is for the US dollar.

3. POWELL’S OUTLOOK & GUIDANCE – The last piece of the puzzle will be Fed Chairman Powell’s outlook and forward guidance. There’s no question that policy will remain accommodative for the foreseeable future and the door will remain open to more easing. However will Powell believe that worse case scenario has been avoided like his counterparts in other parts of the world? Does he see a stronger pickup in the second half as the labor market recovers? How worried is he about a second wave of the virus. Low interest rates and ample liquidity has been the main catalyst for the economic and stock market recovery – any hint that this could send the greenback and stocks plunging lower – a consequence Powell will be keenly aware of.

The Fed’s monetary policy announcement and economic projections will be at 2pm NY time followed by a press conference from Fed Chair Powell at 2:30pm NY time. There will certainly be a big move in the US dollar when the dot plot and economic projections are released followed by consolidation before Powell’s press conference. We believe their initial outlook will be grim, leading to further weakness for the greenback but Powell could be less pessimistic, pointing out the signs of recovery, which could moderate the dollar’s losses. Currencies that will benefit the most from US dollar weakness should be the Japanese Yen, Canadian, Australian and New Zealand dollars. Currencies that will be hit the hardest by unexpected optimism should be all high beta currencies but euro and sterling in particular.