US Fed monetary policy announcement fails in containing USD slide

The US Fed’s monetary policy announced failed to stem greenback’s slide. The greenback traded lower against most of the major currencies, except Canadian and Swiss currencies, which rallied on the back of short covering.

The outcome of the FOMC meeting was less dovish. The central bank left interest rates unchanged, dialed up their expectations for growth and put some specific numbers around their Treasury and mortgage backed securities purchases. They didn’t extend the maturity of asset purchases which was widely anticipated and the decision to be less aggressive is supported by Fed Chairman Powell’s view that the economy should perform strongly in the second half of 2021 thanks to the vaccine.

Greenback jumped in response but the rally lost its sizzle when it was made clear that the Fed will continue buying bonds until there is substantial progress made on its goals. It will also give ample warning before tapering bond purchases and if needed, have the flexibility to provide more accommodation.

The main takeaway was that while the Fed has been swayed by vaccine optimism, it will be a long time before they act on those views and start to unwind stimulus – hence USD weakness may continue.

Meanwhile consumer spending was significantly weaker than expected in November. Spending in October was revised lower as well, putting retail sales down slightly versus the small increase previously reported.

Online spending was strong but not strong enough to offset weakness elsewhere. Between rising jobless claims, surging virus cases and new restrictions that limited mobility last month, US shoppers spent less.

Unfortunately less spending on holiday gifts is likely to persist into December posing a big problem for fourth quarter growth. Widespread vaccine distribution is on its way, until that becomes reality.

With that said, Republicans and Democrats are talking about progress being made on stimulus talk. This plan should include direct payments (up to $600 per person), 16 weeks of $300 extra unemployment benefits and more PPP grants. House Democrats have been advised to stay in DC until relief deal is reached, another sign that it could happen soon. Stocks should have responded more positively to these developments and if/when an agreement is reached, we expect a more significant rally in equities that will carry over to currencies.

EUR and GBP rose to fresh 2.5 year highs on the back of USD weakness and stronger PMIs. Eurozone data was unambiguously positive with manufacturing and services activity improving in the month of December. Between all recent reports, the evidence is now clear that recent lockdowns did not take a big a toll on the economy. Manufacturing in particular seems to be doing well but improvements have also been seen in services.

The UK reported faster manufacturing growth but service sector activity continued to contract despite expectations for a mild expansion.  Nonetheless, GBP was up as the UK signs a custom trade agreement with the US.  Investors haven’t given up hope for a Brexit deal after European Commission President Ursula von der Leyen said “there is a path to an agreement now,” suggesting that a deal could be made in the next few days.

In the meantime the main focus will be on upcoming Bank of England meeting. No one expects monetary policy to be changed but the central bank will probably indicate that it was ready to provide more stimuli if there’s Brexit disruption.  Analysts would not be surprised by a muted reaction to BoE.

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