US Dollar Outlook Hinges On FOMC Guidance, Fed Balance Sheet

USD price action will be front and center during Wednesday’s trading session with the Federal Reserve scheduled to release its latest interest rate decision at 19:00 GMT. This will be accompanied by an update to the central bank’s quarterly economic projections and will be followed by Fed Chair Powell’s press conference due to start Wednesday at 19:30 GMT.

CHART OF FEDERAL RESERVE ECONOMIC PROJECTIONS (SEPTEMBER 2019)

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Chart of Federal Reserve Summary of Economic Projections and US Dollar Outlook

Source: Federal Reserve

I recently outlined how the US Dollar outlook is fixated on trade talks, the most recent jobs report and forward guidance provided by FOMC officials. The FOMC has slashed its policy interest rate by 0.75% so far this year after cutting the federal funds rate by 25-basis points at the last 3 consecutive Fed meetings (deemed a mid-cycle adjustment).

With the Fed relatively turning less-dovish since the end of October, which was highlighted in FOMC minutes from the most recent Fed meeting, USD price action could catch a bid if the Fed underscores its firming monetary policy stance. This will likely be conveyed in the updated summary of economic projections and the median target federal funds rate forecast in particular.

CHART OF FOMC INTEREST RATE CUT PROBABILITIES

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Chart of FOMC Interest Rate Cut Probabilities and US Dollar Outlook

The Fed still appears slightly accommodative, however, judging by futures-implied probabilities for future FOMC interest rate cuts. Although the market is overwhelmingly expecting the Fed to stand pat on rates this December, rates traders are currently pricing in roughly 0.3% of easing over the next 12-months with a futures-implied target FFR of 1.323% by December 2020.

This compares to the current FFR target range of 1.50-1.75%. The convergence between currently priced market expectations and FOMC projections stands to overwhelmingly drive the direction of the US Dollar with the recent global rate cut cycle seemingly on pause.

CHART OF FED BALANCE SHEET

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Chart of Fed Balance Sheet and US Dollar Outlook

Another primary fundamental factor steering USD price action and the broader DXY Index – a popular basket of major US Dollar currency pairs – is details on changes in the Fed balance sheet. The Federal Reserve has inflated its balance sheet by a staggering $300 billion since the beginning of September and reverses nearly half of the tapering throughout 2018 and majority of this year.

Though Fed Chair Powell steadfastly claims that the surge in assets held by the US central bank over the last 4-months is not to be confused with quantitative easing. Rather, the sharp rise in the Fed balance sheet is owed to the FOMC injecting cash into the market via overnight repos aiming to ease recent funding pressures. Correspondingly, a rise in the Fed balance sheet (and supply of US Dollars outstanding) poses a major threat to USD price action and could continue to exert downward pressure on the broader DXY Index.

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