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US Dollar Resurgence May Continue As Fed Balance Sheet Contracts

US Dollar Resurgence May Continue As Fed Balance Sheet Contracts

Daniel Moss, Analyst
US Dollar Basket Chart

US Dollar, Federal Reserve, FOMC, - Talking Points:

  • The US Dollar’s tentative recovery may continue into the upcoming week
  • Federal Reserve’s dovish outlook fueled the recent appreciation in the greenback
  • Will the recent $74 billion contraction of the central bank’s balance sheet fuel further dollar strength?

Fundamental Forecast for USD: Bullish

Swelling fears of a second wave of coronavirus infections has fueled the recent risk aversion seen in financial markets and ignited a tentative recovery in the haven-associated US Dollar.

Federal Reserve Chair Jerome Powell’s surprisingly dovish comments on June 10 catalyzed the initial USD surge, suggesting the “decline in real GDP in the current quarter is likely to be the most severe on record” with “considerable risks to the economic outlook over the medium term”.

However, the implementation of the Secondary Market Corporate Credit Facility (SMCCF) on June 15 calmed investors and temporarily suppressed the appreciation of the greenback, as the central bank “begins buying a broad and diversified portfolio of corporate bonds to support market liquidity and the availability of credit for large employers”.

US Dollar price chart

USD index chart created using TradingView

Nevertheless, Chair Powell’stestimony before the Senate Banking Committee reinvigorated dollar bulls, as he echoed the tone set in the preceding FOMC meeting suggesting “significant uncertainty remains about the timing and strength of the recovery” as “the levels of output and employment remain far below their pre-pandemic levels”.

Recent economic data compounded the risk-off tilt as the number of Americans filing for unemployment benefits last week exceeded market expectations, possibly confirming fears that the recovery may have extended beyond the fundamentals.

Federal reserve assets and liabilities balance sheet

Source – Federal Reserve

In the absence of market moving events in the upcoming 7 days investors may focus on the recent $74 billion contraction of the central bank’s balance sheet in the last week, which could be an underlying factor behind the recent surge seen in the US dollar.

A continuation of this trend could concern market participants and possibly induce further risk aversion, as the supportive monetary back-stop of the rally from the March lows may be gradually dissipating.

Economic calendar

-- Written by Daniel Moss

Follow me on Twitter at @DanielGMoss

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.