Will the U.S. Dollar Keep Climbing?

The currency market is in anticipation, and for now, the situation is in favour of the US dollar. The US Federal Reserve system has long been opposing any tougher monetary measures but is eventually accepting their necessity. At the conference in November already the Fed might voice its plans bluntly, reducing asset buyback volumes. However, with all the hints given earlier, the Fed has recently gone quiet and gives no more comments. Does the dollar has any chances for growth? Is the economy strong enough to wind up stimulation? How fast will the Fed decide to increase the interest rate? Let us get into the details of all this; it is important because this makes the perspective clearer.

The Fed is ready for November

These days, the Federal Reserve System of the USA buys bonds for 120 billion USD. The wide consensus among monetary politicians of the Fed demonstrates that the regular or is ready to decrease purchases by 15 billion USD every month. The nearest conference of the Fed will take place on November 2nd-3rd. This is when the plans might be voiced.

What is next? Most probably, if things go right, in February or March-2022 the Fed will start a new spiral of decreasing buyback volumes. I think that first hand the regulator will finish the buyback program and only then will switch to increasing interest rates.

There is hardly a way back: American inflation is too high to keep pumping the system up with the money. Meanwhile, the overall state of the economy allows removing some stimulation. Fast course of the vaccination campaign and increased federal spending of 2.8 trillion USD help the economic system recover and feel good. There is definitely a base for tougher monetary conditions.

How does the economy feel?

The first assessment of the US GDP for Q3 shows growth by only 2% q/q against the forecast 2.5%, while previously it grew by 6.7%. These are very small values. Of course, there will be two more releases, each one traditionally improved. However, right now and with these statistics, there is nothing to be happy about. Personal consumption in Q3 grew by only 1.6% after sky-rocketing by 12% in Q2. Of course, this was due to the low base effect in Q2, yet the divergence between real and forecast digits is substantial.

Can this postpone the reduction of stimulation by the Fed? I do not think so.

A couple of words about inflation

At the conference in November, the US monetary authorities will note that the price pressure will be falling as it is, without any tough measures. A decrease in inflation, to put it simply, is expected earlier than a decision to increase the interest rate. If the expectations meet reality, things will go smoothly.

Now the CPI in the USA is 5.3%, which is much higher than the aimed 2%. However, it must be noted that during the pandemic the expenses of Americans on goods increased noticeably while the demand for services dropped. The situation gets balanced out, stabilizing the inflation, while the economy is getting back to normal. However, if interest towards goods will keep growing, this might require increasing rates preliminary just to cool the economy down somewhat.

Interest rates: when will they grow?

Now the interest rate in the USA is at its target level of 0-0.25% annually. It can be called zero or aiming at zero

If we remain confident that there will be no more disasters, the Fed must wind up the stimulation program completely in mid-2022. Inflation by then must have dropped under 4%, ideally — 3.0-3.5%. Then the Fed will be able to start lifting the rate in Q3, 2022. However, most probably, this will happen at the beginning of 2023.

Over the course of 2023, the interest rate might grow to 0.6%. I guess, the Fed will be acting smoothly, consistently. Jerome Powell is definitely not going to hurry here. There is no need to increase the interest rate if the economy is not ready for this.

Also note that the rate will be growing faster if inflation sky-rocketing, escaping any control.

Perspectives of the dollar

If the Fed remains consistent the USD will get into a long-term ascending channel. As long as the volume of stimulation will be decreasing, the free money flow will also be smaller. This is a good thing for the USD.

In November, EUR/USD might fall to 1.1550 and remain between 1.1500-1.1700 until the end of the year. Surges of volatility are not excluded.

By Dmitriy Gurkovskiy, Chief Analyst at RoboForex