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Fed Cautiously Optimistic about Recovery with Fiscal Support. USD Upside Limited as Accommodative Policy Remains in Place

The FOMC minutes for the January meeting revealed that policymakers were cautiously optimistic over the economic outlook. Meanwhile, it also dampened hopes of tapering. US dollar’s rebound has been driven by more upbeat economic data and rising yields. However, the Fed’s pledge to maintain an ultra accommodative policy should keep upside limited.

The members acknowledged that the economic outlook was “considerably stronger” than at the December meeting, after incorporating the effects of the Phase 4 fiscal stimulus passed in late December and an assumed stimulus bill in coming months. As noted in the minutes, “the stimulus provided by the passage of the [fiscal package] in December, the likelihood of additional fiscal support, and anticipated continued progress in vaccinations would lead to a sizable boost in economic activity”. Regarding the timeframe that inflation would achieve the target, some participants expected “somewhat above 2%” inflation “for a brief period” this spring, while “many participants” stressed distinguishing between one-time factors and the underlying trend. The staff continued to expect inflation to moderately overshoot 2% “in the years beyond 2023”.

Yet, there is no sign of adjusting the monetary policy. The minutes reaffirmed the guidance that asset purchases would continue at the current pace “until substantial further progress toward its employment and inflation goals had been achieved”. This would take “some time” as “the ongoing public health crisis would continue to weigh on economic activity, employment, and inflation and posed considerable risks to the economic outlook”. Moreover, “various” participants suggested that the FOMC should clearly communicate its assessment of progress toward its longer-run goals “well in advance” of any potential changes.

Economic data released since the last meeting have been upbeat. The unemployment rate slipped -0.4 ppt to 6.3% in January, compared with consensus of 6.7. Nonfarm payrolls increased +49K, after declining -227K in December. Retail sales jumped +5.3% m/m in January, following a -1% contraction month ago. The market had anticipated a mild +1.1% growth. From a year ago, retail sales rose +7.4%. Producer price inflation (PPI) accelerated to +1.7% y/y from +0.8% in December. This also beat consensus of +0.8%. As the economy gathers momentum, US dollar and US yields have also been rising of late. However, the rebound in the greenback should be short-lived as long as the Fed keeps its ultra accommodative monetary policy.

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