USD to inevitably resume slide

The US Federal Reserve held their first 2021 FOMC meeting on Wednesday and based on the performance of US assets, investors don’t expect any surprises from the central bank. The rally in stocks and broad based decline in the USD are signs that investors are looking for steady policy. That means continued commitment to accommodation accompanied by an upbeat outlook for the second half recovery.

It is no secret that December was tough – the US reported its first month of job losses since April 2020, consumer spending dropped for the third month in a row and jobless claims spiked higher. New virus cases surged across the nation, forcing many states to bring back restrictions but none of that sapped investor optimism because ongoing vaccine rollout has made everyone more confident about a second half recovery.

Going into the January policy meeting, the question of whether USD is a buy or a sell hinges on two things – Fed Chair Powell’s recovery outlook and comments on tapering. Over the past month, a number of Fed Presidents suggested that tapering could begin as early as late 2021, if the recovery is strong enough.  If Powell admits to sharing this sentiment, USD/JPY should soar past 104.00 and EUR/USD could break through 1.21.

In December, Powell provided some important clues on where he stands. At the time, they dialed up their expectations for growth and refrained from extending the maturity of asset purchases, which was seen as slightly less dovish. Fed Chair Powell also said the economy should perform strongly in the second half of 2021 thanks to the vaccine but they would still need to continue buying bonds until there is substantial progress made on their goals. On tapering, he noted that they will give “ample warning” before tapering bond purchases.

While more Americans are getting vaccinated every single day, stocks are near their record highs and Biden promises more stimuli, premature taper talk could derail the recovery. There’s no doubt that they’ll discuss this further but the year has just begun and Powell could wait another month or two before setting the stage for less stimuli. For all of these reasons we think that even if the USD rallies on Powell’s positive comments, if he doesn’t add fuel to taper talk, the rally should be seen as an opportunity to sell higher as the USD will inevitably resume its slide.

For the second day in a row, the New Zealand currency was the best performing currency. In contrast to manufacturing, which contracted sharply in the month of December 2020, the contraction in services eased with the PSI index rising to 49.2 from 46.7. Services led the decline in November 2020 and it could now be leading the recovery. We won’t know until next month but for, low virus cases, USD weakness and good data contributes to rally. The Australian and Canadian currencies also moved higher with AUD/USD likely to extend its gains if the report shows CPI growth quickening in the fourth quarter.

GBP/USD closed in on 2.5 year highs following better than expected labor data. Thanks to the country’s furlough scheme, there were fewer job losses and strong wage growth. New virus cases are also beginning to fall, which is positive for the country’s prospects. With no data on tap EUR lagged behind all of the major currencies.

 

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