Conor Beakey
July 23, 2021

Dollar Softens As The US Federal Reserve Remains Dovish

Dollar

The dollar opens this morning slightly softer, with cable trading at a month-to-date high above $1.39 and EUR/USD operating at the $1.185 mark. The emergence of dollar weakness followed yesterday’s key Fed rate-setting meeting, despite an outcome that was broadly in line with expectations. No changes to policy were made as anticipated, though in its meeting statement the Fed did acknowledge that the economy has made progress toward reaching the targets necessary to begin tapering its asset purchase programme. However, this is hardly a surprise given that CPI inflation came in at 5.4% y-o-y in June and the economy is projected to have returned to its pre-pandemic level in Q221. Heading into the meeting, in-line with consensus we anticipated that the Fed would not commence the tapering process until Q122 and we heard little yesterday to suggest that this timeline will be brought forward.

With respect to the economic outlook, Chair Powell continued to guide in the press conference that while inflation is coming in sharper than the central bank had anticipated and may prove more persistent, it will subside over time. As a result, monetary policy tightening is not the appropriate response, with Powell arguing that this would require a significant improvement in labour market conditions. The unemployment rate was put at 5.9% in June, versus 3.5% in February 2020. Meanwhile, the Fed Chair acknowledged the risk posed by the delta variant to activity but indicated that the economic implications should be relatively modest.

Today, the focus will remain on the US, with Q2 GDP figures due. The economy is forecast to have expanded by 8.2% in annualised terms, picking up from 6.4% growth in Q1 as the lifting of Covid restrictions saw pent-up demand released. Given fiscal stimulus measures were largely concentrated in the opening quarter, we see some scope for a slight downside surprise. This could keep the dollar on the back foot today, though it is worth noting that the lagging nature of GDP data means they are not typically a major mover for FX markets.

Sterling

Sterling continued to attract solid support yesterday, with GBP/EUR holding around the €1.175 mark. A modest deterioration in the Covid-19 backdrop, with cases rising by 4,000 to circa 28k after seven consecutive declines failed to stall the currency’s rally. Looking to the day ahead, a quiet UK schedule suggests that the action in its main pairs will be driven by the non-sterling half.

Euro

A busy calendar is in store in the eurozone today, though the data may not offer significant direction to the euro. The EC sentiment indices for July are due this morning and will offer timely insight into how the economy is performing at the start of Q3. The data are set to remain consistent with strong growth as the continent bounces back from lockdown, with concerns over the delta variant providing some modest downside risk. In terms of FX impact, however, while the data are a better gauge of activity than the PMIs, they typically attracted limited market attention.

Flash July inflation figures in Germany will also be of interest today, with the year-on-year rate forecast to pick up to 3.0% on the back of base effects associated with a reversal of temporary VAT cut. With this spike well signalled and the ECB guiding it will see through such distortions, we don’t anticipate the data will generate much euro impact, though the domestic reaction will bear watching ahead of September’s election given the Germans’ long-held aversion to inflation.

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