Analysts at MUFG Bank, point out that the new Federal Reserve’s framework will become more negative for the dollar if the central bank loosens policy further and/or inflation picks up meaningfully.
Key Quotes:
“The USD has fallen back towards recent lows following the Fed’s decision to update their “Statement on Longer-Run Goals and Monetary Policy Strategy”. The next key support level for the dollar index is provided by the 18th August low at 92.127. The Fed has triggered a fresh bout of USD selling after it decided to adopt a “flexible form of average inflation targeting”.
“The new policy framework is intended to help keep real yields low well into the economic recovery by dampening expectations for rate hikes until the labour market has tightened significantly, and by encouraging higher inflation expectations through displaying a greater tolerance to allow an overshoot in the future.”
“The Fed’s ability to help generate higher inflation will now be tested. Market participants’ will be watching closely to see if the Fed decides to loosen policy as soon as at the September FOMC meeting in order to provide more impetus for higher inflation. The more successful the Fed is at lifting inflation without tightening policy, the worse the outcome ultimately will be for the USD.”
“In the short-term, we believe the shift in the Fed’s policy goals was already well anticipated. The US rate market had already pushed out the timing of the first hike until late in 2023. It should help dampen further USD weakness for now. More aggressive Fed easing and/or evidence of higher inflation will be required to trigger a bigger sell off.”
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