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Will the Fed Stop the USD Decline?

27 July 2020 By Mircea Vasiu

The week ahead is all about the Fed and the US Dollar (USD). Since the coronavirus pandemic reached the Western world four months ago, the USD performed differently – it appreciated at first, then sold off massively. 

This week is all about the Fed and its message to financial markets. With no end for the pandemic in sight, but with fiscal support set to expire in the months ahead, the Fed is pressured to do more. Considering the November elections too, the Fed has a difficult job in the months ahead.

July 2020 FOMC Meeting Preview

The FOMC Meeting this  Wednesday ends a difficult period for financial markets and societies in general.

Although August is typically a holiday month, with little or no price action worth mentioning, this August may be different. After the ECB meeting and the EU Summit, the Euro surged across the board. It gained ground, especially against the USD.

One would think that the rise is due to the Euro positive fundamentals if it were not for other currency pairs signaling something different. The GBP gained as well against the USD, and so did the AUD. Therefore, it would be wrong to attribute the price action in the last two weeks only to the developments in Europe. Instead, the USD declines against other majors.

The coronavirus crisis initially created strong demand for USD. The liquidity issues seen at the end of March were swiftly solved by the Fed. Ever since that moment, the USD began to weaken.

Yet it did not fall against all currencies. Once again, emerging markets’ currencies suffered the most, with the Brazilian Real (BRL) leading the race. Other emerging markets currencies had the same fate – TRY, HUF, or RUB; they all declined significantly against the USD. Therefore, when hearing reports that the USD declines due to the Fed’s easing, it is important to understand that the decline happens only against some currencies.

Economic principles divided the world into developed, emerging, developing, and frontier markets. Yes, the USD declined lately against the developed world’s currencies. However, it gained ground against all other currencies, and investors betting on the UDD against emerging markets’ currencies had much to gain during the COVID-19 pandemic.

This is why Wednesday’s Fed decision seals the fate of the USD for the months until the US election in the fall. Will investors keep selling developed world’s currencies, or is it time to reverse course?