The dollar took another leg lower as quantitative easing is poised to run despite a massive rise in the Fed’s balance sheet.
The US Fed delivered its monetary policy statement yesterday. It left things unchanged, as expected, but things didn’t turn ugly for the dollar until after the press conference was over.
The Fed kept the fund rate in the 0% to 0.25% range and the monthly quantitative easing purchases at $120 billion. It vowed to continue to buy $80 billion in Treasury securities and $40 billion in Mortgage Back Securities (MBS) despite the economic outlook improving sharply in recent months.
The chart shows the Federal Reserve balance sheet expansion since the 2008-2009 Great Financial Crisis. It reveals that the response to the COVID-19 pandemic exceeds all the easing done during the last decade. With no end in sight, what will happen with the US dollar as the world’s reserve currency?
Subtle Shift in the Fed’s Tone
The Fed’s message, though ultra-dovish, did show a subtle shift in tone. While an announcement on tapering (i.e., decreasing the pace of asset purchases) would be a clear hawkish signal, the Fed is just not there yet. It wants to see higher employment and even higher inflation first.
However, the central bank did deliver a slightly hawkish update with its statement: previous mentions of the pandemic posing “considerable” risks were replaced by talk of risk “remaining” (with no mention of “considerable”). This suggests the Fed is tracking improvements in the economy.
These statements matter more than you might think. Traders should not be fooled by the market’s complacency and should remember who is taking the other side of their trades. The 21st-century financial markets are dominated by trading algorithms that buy and sell based on differences between different texts; e.g., differences between two consecutive FOMC statements.
In summary, the Fed delivered a dovish signal. The first-quarter GDP, to be released later today, will reveal if the Fed’s decision to remain accommodative was correct. If the GDP beats expectations, the market may pressure the Fed in the future.