20.05.202115:31 Forex Analysis & Reviews: USD looks for new direction, while markets trying to guess Fed's intensions

Global markets have been in turmoil lately.

The reason for the market jitters is quite simple: inflationary fears are still in place, and the current stance of the US Federal Reserve does not inspire confidence among investors.

The US central bank continues to insist on a large-scale monetary stimulus combined with fiscal measures, pointing to the risk of a slow recovery of the national economy and relatively low employment compared to pre-pandemic levels.

At the same time, the regulator considers the acceleration of inflation to be a temporary phenomenon since it mainly reflects the short-term effect of disruptions in supply chains and the impact of deferred demand.

On the one hand, this should convince market participants that the Fed will preserve its dovish monetary policy. Yet, it raises the question of whether the regulator is able to maintain control over the situation.

Glenn Hubbard, a former Republican economic adviser, believes that the problems of the US labor market are mostly structural and simply "heating up" the economy will not solve them.

The main danger is that the Fed could keep the rates low for too long, and this will ultimately prolong the inflationary pressure that is considered temporary at the moment.

A similar opinion is shared by former US Treasury Secretary Lawrence Summers who said that the Fed's current monetary policy could lead to serious trouble.

"The ultra-soft monetary policy of the US central bank combined with huge stimulus spending from the federal government creates the basis for a vicious circle with respect to inflation," he warned.

Experts note that since April last year, the United States has taken unprecedented measures of monetary and fiscal support. If inflation does not hit higher levels against this backdrop, it will be a real economic miracle.

So, is it worth waiting for the Fed to closely monitor inflation dynamics and does this mean that the idea of the temporary acceleration in inflation may soon disappear?

Yesterday, Fed's minutes from the April meeting were released. The regulator pointed to a sharp increase in economic activity in the United States. At the same time, the Fed warned that the national economy was still far from the goals set by the central bank under the influence of the coronavirus pandemic.

The document also showed that some of the Fed officials see the need to reduce incentives if the situation in the US economy continues to improve.

Unexpected signs of a possible tightening of the Fed's monetary policy surprised investors but, apparently, they considered that it was not worth pricing this into quotes.

US stock indices dropped on Wednesday, ending in the red for the third session in a row. However, they significantly reduced the pace of decline by the end of the trading session.

The 10-year yield jumped to 1.69%, but then corrected to 1.65%.

The greenback strengthened sharply on Wednesday following the release of the minutes from the April FOMC meeting, but it quickly lost momentum. Already on Thursday, the US dollar index went down, sliding by 0.25% to 90.00, but still remained slightly above the low of 89.68 reached in late February.

"The Fed minutes might end the recent period of dollar weakness for now, but it is still too early for a trend reversal," strategists at Commerzbank say.

The US currency has been declining over the past few weeks as Fed officials have repeatedly said they were not ready to discuss the stimulus cut as US inflation will only briefly exceed the 2% target.

"USD may develop its uptrend only if the situation in other countries deteriorates and the market forgets about the idea that took the greenback so deep down - the fear of inflation and the expectation that the Fed will remain committed to super-soft monetary policy until inflation consolidates significantly above the 2% target", analysts at Saxo Bank said.

The next FOMC meeting is scheduled for June 15-16.

The US dollar may rise if Fed officials mention the reduction of QE in the near future, but this growth is unlikely to last long, MUFG experts say.

"The US may face financial challenges as the summer approaches. It is not yet clear how large budged spending will be. It is difficult for the Fed to take any steps without more clarity on fiscal policy," they said.

Meanwhile, Republicans plan to unveil their counter-proposals to the White House regarding Joe Biden's plan to spend $4 trillion on infrastructure and various projects. It is not yet clear whether Democrats will ratify the bill alone or will try to reach a compromise with Republicans. Joe Biden has set July 4 as the date for signing the law.

The dollar's attempt to recover faced strong resistance around 90.30. After yesterday's rebound, the US currency resumed its decline on Thursday.

"The greenback is still under pressure. A breakout of the recent low at 89.68 will not come as a surprise and would indicate that the US dollar index is heading towards the early January low of 89.21. However, in order for the index to reach 89.21, it will need to maintain the current rapid pace of decline and stay below the resistance represented by the descending trendline near 90.65. Further support is found at 88.85 and 88.25," specialists at UOB said.