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Fed changes diagnosis. Review as of 18.06.2021

Where crying didn’t help the ECB, a dot plot was enough for the Fed

Financial markets paid too much for believing in Fed’s passivity

Never argue with a doctor, or your diagnosis may change. Up to the middle of June, markets believed the inflation boom was temporary and the Fed would remain passive for a long time. However, the “doctor” changed the diagnosis all the same. The Central bank now expects the economy will get stronger and is ready to raise rates as early as 2023. Twice. Even though Jerome Powell repeated many times that a “dot plot” wasn’t a call for action as it didn’t express the whole FOMC’s opinion, the EURUSD bulls had to capitulate. 

A stable person is a very convenient shooting target. The Fed was so successful in persuading investors of its stable passivity that aiming — creating an efficient strategy — seemed to be as easy as pie. So why shouldn’t we sell the dollar when no other bank can afford to be more peaceful than the Fed? That’s what hedge funds and other speculators have been doing since April — selling the greenback and buying the Canadian dollar, the Norwegian krone, and the British pound  

The euro was one of the leaders in that race, although Frankfurt didn’t want to voice its willingness to normalize monetary policy, as Ottawa, Oslo, and London did. The ECB could only cry quietly, in the form of verbal interventions by Governing Council’s members, or loudly, in the form of Christine Lagarde’s press conference following the ECB’s meeting in June.  

– My son, why are you crying so loudly?

– I tried crying quietly, and nobody heard.

It turns out it all wasn’t because of growing vaccination rates in the EU, selling the first bonds backing the EU recovery fund, or expectations of an economic boom in the eurozone after lockdowns. It’s because the USD is oversold amid the Fed’s passive and transparent stance. Unfortunately, your weapon may hurt you: the Fed promised to be transparent and made investors believe in its passivity. As a result, financial markets exploded once they saw the Central bank waking up.

People’s relationship with time is complicated. They don’t know either how to kill time or how to get more time. Projections for core PCE inflation suggest Jerome Powell and his colleagues continue to believe that the recent spike in inflation was temporary. Still, they prepared a withdrawal route: if something goes wrong, the Fed is ready to step in. The question is how long the Fed will remain patient. How long will it tolerate CPI at 5% and more? Six months? Twelve months? Eighteen months? Can the federal funds rate be raised as early as 2022? If so, should we forget about EURUSD at 1.25? 

Nevertheless, that won’t happen soon. In 2022, the eurozone’s economy will be recovering faster than the US one. Will it be a reason for the ECB to start a new life?

– I want to start a new life every day.

– What’s the problem then?

– My old life.


Price chart of EURUSD in real time mode

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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