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Dollar May Benefit from Fed's Lack of Action
Written by article default Wednesday, 13 October 2010 08:15
Financial markets reacted positively to the release of the minutes to the September Federal Open Market Committee (FOMC) policy meeting, with the U.S. Dollar declining broadly and equity markets rallying back into the green after spending most of the day modestly lower. Was this the correct reaction?The minutes indicated that the Fed was willing to take additional steps to support the economy if warranted, but that there was merit “in accumulating further information before reaching a decision about providing additional stimulus.”
We can interpret this statement to mean that the Fed is there as a backstop, ready to do all that it can to prevent a second economic downturn, but that there is no urgency for immediate action. In fact, it is likely that the Fed would rather not take any further action, for it is obviously a more ideal scenario to have the economy recover on its own.
With regard to how the Fed currently views the economy, members generally felt that “the data has been mixed, with readings early in the period generally weaker than anticipated but the more-recent data coming in on the strong side of expectations.” The assumption is that if the data keeps coming in on the “strong side of expectations,” the Fed will not ease further. On the other hand, another round of weak economic data would probably prompt the Fed to act. In this vein, the minutes went on to say “unless the pace of economic recovery strengthens or underlying inflation moves back toward a level consistent with the Committee's mandate, it may be appropriate to take action soon.”
Whether the Fed eases further or not is a crucial factor that will drive forex markets in the near-future. The U.S. Dollar in particular has been burdened by the anticipation of more quantitative easing by the central bank. A stronger-than-expected economic recovery and the absence of such easing may be the catalyst that finally leads to a bottom in the greenback. Otherwise, a weak economy and more stimulus will merely reinforce the extremely strong trend to the downside.
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