The developments around a new stimulus package and Trump’s health will likely overshadow everything else this week, but as far as scheduled releases go, the main event will be the minutes of the latest FOMC meeting at 18:00 GMT Wednesday. This was when the Fed adopted its new inflation overshoot regime and markets will be looking for hints on whether more stimulus is in the pipeline. They are unlikely to find any, which may briefly boost the dollar.
From ‘all in’ to ‘check’
The Fed has gone all out in its fight against the pandemic this year, and the latest move was to signal that even if inflation exceeds its 2% target for some time, it still won’t raise interest rates. This shift was unveiled in September, and it essentially means that even if the economy improves drastically, rates will still not be raised for a long, long time.
By convincing markets that the economy will be allowed to run hot, the Fed hopes to make its job easier. If investors believe inflation is going to overshoot, it may become a self-fulfilling prophecy. Expectations that rates will stay low no-matter-what could loosen financial conditions further, drive borrowing rates even lower, and ultimately power up the economic recovery.
And yet, the Fed seems to be getting cold feet. Even though it announced this shift, it did not back it up with new measures to lift inflation. That left investors disappointed, pushing the dollar a little higher and stocks slightly lower after that meeting.
The Fed basically signaled that it has gone from ‘all in’ to ‘check’ in poker terms. While Chairman Powell kept the door open for adding more stimulus, his tone implied there is no great rush to do so. Of course, one key reason for waiting is that the Fed wants to see how much spending the Congress will deliver first, before taking any major decisions.
What is the Fed’s next step?
This is where the upcoming minutes come in. Markets will look for any details around what additional measures the Fed might take if the recovery stalls, and whether there is widespread support within the Committee for new measures.
Back at this meeting, the vote was 8-2 in favor of the new inflation approach, with Kaplan and Kashkari dissenting but for very different reasons. Kaplan was on the hawkish end, not wanting to tie the Fed’s hands for many years by committing to rock bottom rates, whereas Kashkari wanted to go even further than the Committee by tolerating inflation overshoots for longer periods.
Hence, there are very different views among policymakers, and if the minutes hint that Kaplan is not alone, we might see similar market reactions as right after the meeting. But in general, the minutes are unlikely to tell us anything revolutionary. There has been a parade of Fed speakers lately, and if there was a consensus on doing anything more, we would probably know already.
Minutes just a blip, but stimulus deal matters
In the big picture, what will really drive the dollar and stock markets is whether the week ends with a US stimulus deal or not. If an agreement is reached, that could boost equities but hurt the dollar, as deficits concerns resurface. On the flipside, no agreement could spark the opposite reactions.
Now as for which is more likely, the tea leaves suggest a deal is more likely right now, given what the White House and Democrats have been saying lately. However, that could change in an instant and the time window for reaching an agreement is closing fast. We will probably know by the end of this week.
Taking a technical look at euro/dollar, a potential move back above 1.1825 could meet resistance around 1.1870.
On the downside, if the bears penetrate below 1.1760, the next target may be the 1.1695 zone.
