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The US Federal Reserve is a dove, fighting the US dollar

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Fed to keep cash rates unchanged; market optimism puts downward pressure on the USD; some economic data is improving.

The US Federal Reserve recently announced its decision to keep cash rates unchanged, in line with analysts’ expectations.

The bank decided to keep rates close to zero at 0.25 percent, saying the economic situation was improving, although still below pre-pandemic levels.

In addition, the Fed has pledged to continue bond purchases until the economy improves substantially.

During a news conference that followed the announcement, Federal Reserve Chairman Jerome Powell noted that if the economic recovery slows, the Fed will expand its balance sheet and strengthen its commitment to aid the economy until it fully recovers.

Regarding the current level of inflation, Powell said there is empirical evidence that there are disinflationary pressures around the world that are pushing prices down, despite current monetary conditions.

“It’s not going to be easy to get inflation to go up… it’s going to take time. It took a long time for inflation to get back to 2 percent in the last crisis,” Powell said after being asked about the price level. He added that even with the very high level of accommodation provided by the bank, it will take some time for the inflation level to return to the desired level.

The latest Consumer Price Index data, while higher than expected, is still well below the Federal Reserve’s inflation target, currently set at 2 percent.

The spread of the COVID-19 virus continues to put pressure on the economy and poses significant risks to the medium-term economic outlook. So far, 17,394,314 cases of the coronavirus and 314,629 deaths have been reported in the United States. The recent increase in infections is expected to be countered by the current vaccination campaign.

Powell noted that despite recent positive progress on COVID-19 vaccines, the late surge in infections is concerning, adding that the coming months could be very challenging.

This week saw the release of some important data on the current state of the US economy. The Federal Reserve Board of Governors reported on Tuesday that industrial production rose more than expected in November, up 0.4 percent month-on-month, though down from 0.9 percent the previous month. Analysts had expected growth of 0.3 percent.

On Wednesday, markets learned that consumption levels fell in November, signaling that the economy is in shambles. Retail sales fell 1.1 percent, more than expectations for a 0.3 percent decline and significantly worse than the previously reported 0.1 percent decline. Excluding the auto sector, retail sales fell 0.9 percent after falling 0.1 percent in October. The number was also below analysts’ expectations of a 0.1 percent gain.

A preliminary manufacturing PMI reading of 56.5 signaled an expansion in the sector in December. This is lower than the previous month’s reading of 56.7 and higher than the forecast of 55.7.

The services sector also showed signs of expansion – albeit slower than expected – at 55.3 after the previous month’s reading of 58.4. The composite PMI came in at 58.6, up from the previous month’s 55.7 and showing expansion in the business sector.

Optimism brought to the markets by the start of the vaccination campaign put negative pressure on the dollar, favoring riskier currencies and assets such as US stocks.

“The dollar has softened as the world becomes more optimistic about the growth outlook in 2021,” said an analyst at CMC Markets.

The U.S. dollar index, which measures the greenback’s performance against a pack of its major rivals, is down 1.18 percent so far this week, giving up the previous week’s gains. On a monthly basis, the currency continued its two-month losing streak as it fell 2.14 percent after falling 2.31 percent in November.

In light of our last report, Economic data appears to have improved, especially in the inflation area.

The quarterly gross domestic product figure has been revised down since our last report, now standing at 33.1 percent, slightly less than expected and significantly better than the 31.4 percent decline in the previous quarter.

The latest CPI report showed a better-than-expected performance on the money front. CPI rose 1.2 percent year-on-year in November, unchanged from the previous month, though still higher than expected. In monthly terms, it rose 0.2 percent, more than expected, and was unchanged from the previous month.

The latest data from the labor market also positively missed analysts’ expectations. Unemployment was 6.7 percent in November, down from October’s 6.9 percent and below expectations of 6.8 percent.

Basic chart

  • The Department of Commerce will release data on building permits and housing starts tomorrow.

  • Also tomorrow, the US Department of Labor will release continuing and initial jobless claims data.

  • The Philadelphia Federal Reserve will release its manufacturing survey on Friday as well.

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