US Dollar May Rise as Markets Stockpile Cash Despite Fed Rate Cuts

US DOlLAR, FEDERAL RESERVE, RATE CUTS – Talking Points:

• Fed rate cuts sink bond yields, but credit conditions are not improved
• Markets may be stockpiling cash, signaling worries about crisis ahead
• US Dollar may resume 2-year uptrend on growing liquidity premium

Financial markets have been betting on a dovish turn in Fed monetary policy since late 2018 as a downturn in global economic growth that started to set in earlier that year deepened. Priced-in expectations for the target Fed Funds rate 12 months into the future plunged, pulling benchmark bond yields lower along the way.

Chart created with TradingView

FED STRUGGLING TO DELIVER STIMULUS WITH INTEREST RATE CUTS

Curiously, that does not seem not seem to have loosened credit conditions in a meaningful way. The object of rate cuts is to reduce the cost of borrowing, encouraging consumption and investment to boost growth. Data from Bloomberg suggests that has not occurred.

Financial conditions loosened in anticipation of the rate cut cycle in the first quarter of 2019. Since early may however, they have been tightening anew even as the Fed policy outlook has become ever-more dovish. Put simply, Fed stimulus does not seem to be transmitting into the broader credit markets.

This is an ominous sign, suggesting that market participants find the Fed’s efforts as an insufficient bulwark against whatever turmoil looms ahead. To that end, they appear to be stockpiling cash for whatever crisis-inspired shortage emerges rather than letting it flow into the markets.

US DOLLAR MAY RISE AS MARKETS PUT PREMIUM ON LIQUIDITY

This might explain how the US Dollar has managed to rise rather than fall so far this year even as the Fed has transitioned from hiking to cutting interest rates. The most widely-used global currency is the undisputed liquidity haven, putting a premium on its value when cash is in demand.

This might provide the fundamental backdrop for the Greenback to launch the next phase in the uptrend from early-2018 lows. As outlined in the latest US Dollar technical forecast, a corrective pullback akin to the one witnessed late last year may precede the “phase 3” of the structural ascent.

US Dollar average chart created with TradingView

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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com

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