theDXY its showing a lot of up momentum and strength for the, EURUSD]The Fed is not adding anything new at the moment and, in addition, Europe is unlikely to recover faster than the US, so EUR optimism and USD pessimism should be reviewed at this juncture. I still expect greater EURUSD downward pressure in the near future. Trade with caution also we have elections coming.
Comment
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Things could get a little less comfortable for USD bears.
1) Rising COVID-19 figures in Europe, potentially accompanied by more stringent restriction measures soon.
2) No additional Fed moves.
Conclusion: Risk sentiment is shaky, short-term USD recovery remains likely.
The Fed’s update policy strategy and enhanced forward guidance appear generally consistent with this view. The Fed foresees long-term disinflationary pressures as a result of a protracted period of high unemployment. Under the new strategy, the Fed expects to long rates at zero until the inflation reaches 2% to encourage above target inflation and firm up inflation expectations. This was the message delivered in most recent statement and confirmed in the Summary of Economic Projections.
The Fed’s stance appears to favor further policy action to accelerate inflation. As a group, the Fed has steadfastly downplayed positive economic data in favor of a laser-like focus on downside risks to the outlook. Moreover, the median Fed meeting participant does not anticipate inflation exceeding during the forecast horizon that now extends to the end of 2023. That implies the Fed will continue to be pressured to do more to accelerate inflation and the only reason it has yet to do more is lack of time to build an internal consensus on next moves. The easiest, lowest cost next move is yield curve control although the Fed has downplayed that option. The next move is to shift asset purchases to the long end of the yield curve. The threat of these two potential outcomes maintains downward pressure on long term yields.
The Fed has so deeply embraced the downside risks dominate/this is a repeat of the last recovery framework that they abruptly pivot in a hawkish direction when the weight of evidence to the contrary becomes impossible to ignore. This could mean reducing asset purchases or bringing forward expected rate hikes. Rapid shifts in the outlook are not unprecedented; for instance, the Fed typically dismisses negative economic news prior to a dovish shift.
Bottom Line: The baseline scenario is that conditions and Fed policy mesh such that the yield curve remains flat. This is arguably the message from the Fed’s last policy meeting in which the Fed operationalized the new framework. Continued better than expected outcomes are a threat to this scenario. I am sensitive to this risk given that the economy has outperformed my expectations such that it seems clear that this recession does not follow the dynamics of the last.
Wzielfx
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There are two Fed narratives developing in the background, one that favors a flatter yield curve and another that favors a steeper curve. As of now, it appears that the flat curve scenario dominates the conventional wisdom while the steeper curve is the risk. I think it is worth reviewing the basics of the two scenarios so we can keep an eye on which unfolds in the coming months.
The Fed’s stance appears to favor further policy action to accelerate inflation. As a group, the Fed has steadfastly downplayed positive economic data in favor of a laser-like focus on downside risks to the outlook. Moreover, the median Fed meeting participant does not anticipate inflation exceeding during the forecast horizon that now extends to the end of 2023. That implies the Fed will continue to be pressured to do more to accelerate inflation and the only reason it has yet to do more is lack of time to build an internal consensus on next moves. The easiest, lowest cost next move is yield curve control although the Fed has downplayed that option. The next move is to shift asset purchases to the long end of the yield curve. The threat of these two potential outcomes maintains downward pressure on long term yields.
The Fed has so deeply embraced the downside risks dominate/this is a repeat of the last recovery framework that they abruptly pivot in a hawkish direction when the weight of evidence to the contrary becomes impossible to ignore. This could mean reducing asset purchases or bringing forward expected rate hikes. Rapid shifts in the outlook are not unprecedented; for instance, the Fed typically dismisses negative economic news prior to a dovish shift.
Bottom Line: The baseline scenario is that conditions and Fed policy mesh such that the yield curve remains flat. This is arguably the message from the Fed’s last policy meeting in which the Fed operationalized the new framework. Continued better than expected outcomes are a threat to this scenario. I am sensitive to this risk given that the economy has outperformed my expectations such that it seems clear that this recession does not follow the dynamics of the last.