New approaches to the Fed’s monetary policy may change the financial market fundamentally

When you’re close to your destination, it makes no sense to make long-term plans. You need to take decisions, based on the state of road you are going. The Fed vice chairman Richard Clarida suggested that the interest rate is close to a neutral level, and the importance of the FOMC projections is getting less in this situation. The central bank’s policy will be rather data dependent, getting less transparent. And the uncertainty will increase the volatility in the financial market. The regulators are abandoning ultra-easy monetary policies, the things are changing. They are getting back to norm.

In the 2015-2018, the Fed has been normalizing its monetary policy, and the dollar rate has been changing according to how the FOMC projections were met by the actual central bank’s measures. Aggressive monetary restriction in 2018 has built a solid foundation for the USD rally. On the contrary, just a single rate hike in 2016, instead of the expected three ones, was pressing the greenback down almost till the presidential election. With this regard, the dollar should be going down as the derivative market has cut the probability of three federal funds rate hikes in 2019 down to 12% from the previous 18%. But for this obstacle, the EUR/USD bears attack would have been much faster.

The federal funds rate is close to a neutral level, and investors can’t know for sure where it will be heading after reaching it. Investors may well follow the Fed’s target rate direction, rather than its pace in the second half of 2019. Disappointing reports on employment, inflation and GDP can well result in the easing of the Fed’s monetary policy, and vice versa. The importance of the macroeconomic statistics will increase, and the FOMC projections will be less important.

Dynamics of federal funds rate

SourceWall Street Journal.

Good news is that until the Fed reaches the final destination of its course, one can base on the former correlations. Talk about a slowdown in the US economy, along with the Fed’s monetary restrictions, suggest moderately negative outlook for the US dollar. However, nobody wants to sell the greenback for two reasons. First, there is no point in entering shorts for the currency, whose issuing central bank is going to hike the interest rate in a few days. Second, the potential escalation of the US-China trade conflict should boost the demand for safe-heaven assets, including the U.S. dollar. I think it the reason why even another batch of Donald Trump’s criticism of Jerome Powell and his team hasn’t stopped the EURUSD bears.

According to the US president’s top economic advisor Larry Kudlow, if the negotiations in Buenos Aires don’t result in any improvement, the U.S. is going to raise import tariffs to 25%, from 10%, boosting them up to $267 billion. The greenback looks quite strong; so, the weakness of the US GDP or some dovish comments in the minutes of the FOMC meeting in November can result in only short-term EUR/USD rise. The market is not willing to sell the dollar actively until the Fed’s meeting in December.


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Price chart of EURUSD in real time mode

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