USD: Next week’s FOMC meeting will be important – MUFG

Next week, the Federal Reserve will have its monetary policy meeting. Analysts at MUFG Bank point out that the FOMC may provide hints of what is to come. They see that now is all about forward guidance. According to them, real yields will undermine the US dollar further. 

Key Quotes: 

“In another sense though looking at the current moves in financial markets, the FOMC may have some time before having to be more explicit with guidance. While US equities hit new postCOVID highs, 10-year UST yields fell to new lows. Fed balance sheet data shows UST bond purchases have slowed to around USD 20bn per week. Add to that the disappointing take- up from the Fed’s new lending facilities and you have a recipe for an unwanted shrinking of the Fed’s balance sheet. The Fed will not want this and while the formal guidance in the statement might not change much next week, Chair Powell’s comments in his press conference may signal plans ahead.”

“September does look more likely for any formal outline of a policy strategy. (...) A clear message of no change in policy until a period after which inflation moves above target would likely have to be reinforced by a possible introduction of a cap in short-term market yields.”

“A commitment to increase QE if balance sheet shrinkage was to persist given the poor take-up of lending programs could also be considered. Some of these ideas may be touched on in the Q&A but overall we would expect a strong message of the need for continued stimulus.”

“Given the capacity for the Fed to expand its balance sheet further, we see its guidance of being fully credible and therefore having a powerful impact on capping nominal yields. The real 10-year yield is already close to a record low and we see fresh lows ahead. The dollar is set to suffer further given the real yield backdrop although September may be the more important moment for the Fed’s guidance.”