How will this week’s Fed meeting impact the US dollar?

With not too much macroeconomic data on tap, focus in financial markets this week will be firmly on Wednesday evening’s Federal Reserve monetary policy meeting.

We think that the meeting will be a largely neutral one for the US dollar. Policymakers will likely continue to warn over the recent move higher in US inflation, which last month jumped to fresh multi-year highs. The committee will, however, also probably highlight the downside risks to growth posed by the latest wave of virus infection triggered by the aggressive spread of the delta variant. New daily cases have increased to three month highs in the US. While this is not yet a significant cause for alarm, it may trigger another tightening in restrictions in those states that have so far lagged behind in vaccinations.

We think that the latter will most likely delay the need for policy tightened from the Fed and we do not expect a formal announcement on QE tapering until the September meeting, when fresh macroeconomic and interest rate projections will be released. We do, however, believe that discussions will be had surrounding a tapering in asset purchases, as was the case in July. Any word on such conversations in the bank’s accompanying communications could be seen by investors as a US dollar positive.

Risk sentiment flip-flops amid ongoing virus concerns

Leading up to this week’s Fed meeting, risk sentiment has flipped one way and then the next. The dollar spent most of London trading on Monday on the back foot, with risk currencies advancing as concerns abated surrounding the latest aggressive spread of the COVID-19 virus around much of the world. Caseloads have begun to increase aggressively again in many of the key economic areas, although as long as the vaccines prevent a meaningful uptick in deaths, the FX market won’t go into full-on panic mode just yet. The dollar has, however, strengthened again versus its major peers this morning, with the safe-haven currency continuing to hover around three-and-a-half month highs.

Preliminary Q2 growth data for the US and Euro Area on Thursday and Friday respectively will be keenly watched by the market, although the data runs on a bit of a lag so it may be slightly overlooked by currency traders. Inflation data has taken on much greater importance, so Thursday’s Euro Area CPI numbers may prove a bigger market mover.