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Thursday, July 7, 2022

The Fed Remains on Hold

The CDC said that mask-wearing should begin in areas that see a rise in the spread of the delta variant and not all locations. Most of the transmission of the delta variant is happening in the southern states in the U.S. The decision by the CDC provides some cover for the Federal Reserve to hold off on any decision that they should alter their accommodative monetary policy stance.

The second takeaway is that once the delta variant is under control, the Fed feels that the economic progress is gaining momentum. The Fed is on track to begin the tapering process, whereby they will start to remove some of their bond purchases. There is the chance that tapering begins before the end of 2021, but it’s unlikely that it is announced before the September monetary policy meeting. The Fed will be closely watching the employment figures as well as the inflation information.

The third takeaway is that the Fed continues to believe that inflation is transitory. Fed Chair Jerome Powell defined transitory during his press conference on Wednesday, July 28. Transitory, according to the Fed Chair, means that inflation will begin to decelerate at some point. So, while inflation is accelerating faster than average currently, it will start to slow and accelerate at an average rate.

When you compare prices in July of 2021 to July 2020 during the heart of the pandemic, there is robust inflation. The Fed Chair says that when you compare prices from this July to prices in July of 2022, the increase will decelerate. This concept does not mean that prices will begin to go down; it means that the acceleration in prices will slow. The Fed also believes that only a portion of the basket of prices the Fed observed has increased.

How Does This Impact Forex Trading?

The Fed implies that they will likely keep policy accommodative for a period and then normalize policy. Initially, the Fed will begin to taper its bond purchase program. Remember, the Fed is purchasing approximately 120 billion in government and agency bonds per month. The tapering of the bond purchase program will be the first step in tightening monetary policy.

If the Federal Reserve begins to remove its bond purchases before the EU, the yield differential will start to favor the greenback. The yield differential is one of the driving forces behind forex trading. As yields move in favor of the greenback, the dollar will improve relative to the Euro and other major currencies.

Growth in the U.S. Misses Expectations

On the day following the Fed’s decision, U.S. GDP came out at a less than expected rate. According to the U.S. Commerce Department, Q2 GDP came out at 6.5% year over year compared to the 8.4% growth expected by economists. One of the issues could be that there are not enough workers available to help growth expand. Inventories were down for the second consecutive month. The reason that restocking is slowing is likely because of higher shipping rates, making it difficult for importers to bring their goods into the U.S.

Personal consumption is 11.8% which is considered very hot. Personal consumption expenditures came in at 6.5%, which shows that inflation is accelerating. While this growth figure is strong, it does provide the Federal Reserve with some more coverage to hold off removing any accommodation.

The Bottom Line

The upshot is that the Federal Reserve announced that they would remain on hold until they see further considerable growth in employment. The committee still sees inflation as transitory and that the acceleration in prices will begin to slow. The forex market seems to believe that the dollar will remain subdued until the Fed begins to taper its bonds. With GDP growing at a less than expected rate, it’s unlikely that forex traders will start to lift the dollar in the immediate aftermath of the Fed decision.

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