Dollar Index On The Rise

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Dollar Index On The Rise

ByJin Dao Tai

 MAY 6, 2021

Dollar Index On The Rise

Fed remains cautious despite good progress in economic recovery.

The U.S. Federal Reserve kept its monetary policy unchanged during its meeting last Thursday; interest rate was held at the targeted range of 0-0.25% while monthly bond buying remains at $120 billion. The central bank acknowledged that the recent releases of economic indicators have been strong amid the speedy vaccination programme and the strong policy support. Despite the recovery in the U.S. economy, Fed Chairman Jerome Powell highlighted that the U.S. economy is still “uneven and far from complete” while dismissing the recent inflation pressures to be one-time and transitory, thus not meeting the standard for an interest rate hike. Furthermore, Chairman Powell also emphasized that now is still not the time to consider tightening of monetary policy such as reducing quantitative easing.

Nonetheless, the Fed struck a more optimistic tone in the current rate statement than in the previous statement. In the previous statement, the central bank stated that the ongoing pandemic “continues to weigh on economic activity, employment, and inflation, and poses considerable risks to the economic outlook“. However, the Fed has revised that quoted statement to “continues to weigh on the economy, and risks to the economic outlook remain”, omitting the word “employment”, thus indicating the recognition that the job market is making progress. Also, the Fed shifted from the more dire tone of “poses considerable risks” to the economy to simply stating that risks remain.

Dovish tone may lead to an increase in bond purchase by ECB.

Just like its U.S. counterpart, the European Central Bank (ECB) kept their monetary policy at status quo during their April’s meeting. The Pandemic Emergency Purchase Programme (PEPP) will still continue with a total envelope of €1,850 billion until at least the end of March 2022 while the Asset Purchase Programme (APP) will continue at a monthly pace of €20 billion. However, the central bank expects bond purchases under the PEPP to increase in the coming months.

The expectation that the ECB will be increasing quantitative easing led to the weakening of euro. As the next meeting will be held in June, the central bank will have slightly more than a month to observe how the eurozone economy plays out before deciding on their next plan of attack.

Impact on U.S. dollar index.

The Fed’s announcement last Thursday led to a halt in the recent downtrend of the U.S. dollar index, leading to the formation of a potential support zone at the 90.500 level. Although the Fed is taking a very cautious and conservative approach towards the calibration of its monetary policy, with the current progress made in containing the virus in the U.S., it is likely that the economy will soon recover to its pre-pandemic level. Thus, we are likely going to see a further strengthening in the dollar index.

The same cannot be said for Europe. With the increasing number of infection cases and the existing lockdown measures still in place across Europe, it seems more likely than not that the ECB will have to carry out more policy easing during their next meeting. This may very well lead to a further weakening of the euro, which will directly lead to the strengthening of the dollar index (since it contributes to 57.8% of the index).

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