After selling off throughout the month of April, the greenback finally rebounded on the eve of the Federal Reserve’s monetary policy announcement. The U.S. economy is running hot ahead of the rate decision, but no changes are expected from the central bank, which explains why the U.S. dollar pulled back this month despite good data. The question for tomorrow is whether the Fed will stick to script and say that it is still waiting for “substantial further progress” in the economy or finally acknowledge that its goals could be met sooner than anticipated.
The strength of the U.S. recovery is undeniable, with jobless claims at pandemic lows, consumer confidence at 14-month highs, house prices soaring and retail sales rising at their strongest pace since May of last year. According to the latest reports, ISM service sector activity grew at its fastest pace ever, while the manufacturing ISM index rose to its highest level in nearly 40 years. The best part is that the momentum hasn’t peaked. More than half of American adults received at least one shot of the coronavirus vaccine and the CDC just eased guidelines, saying that fully vaccinated Americans can forego wearing masks outdoors when they are alone or in small gatherings. With warmer weather approaching, these revised guidelines will give Americans the confidence to return to pre-pandemic activities. April will be a very strong month for job growth, with more hiring to follow as the travel industry prepares for a strong recovery.
The Federal Reserve will acknowledge these improvements, which should cushion any losses for the U.S. dollar, but it is widely expected to stay tight-lipped about tapering plans until June, when its economic projections are updated. If virtually no changes are made to the Fed’s language, which includes its view that increases in inflation are transitory, the U.S. dollar will resume its slide. However, if even a small tweak is made to suggest that inflation expectations are moving higher or policy-makers are thinking about balance sheet changes, the U.S. dollar will soar, with USD/JPY taking out 109 easily.
Throughout 2021, the U.S. has led the COVID-19 economic recovery, and at some point other countries will close the gap. But for now, vaccination rates in Europe are slow and some countries in Asia are reintroducing restrictions instead of rolling them back like the U.S. This means that in the near term, even after a FOMC pullback, the U.S. dollar should outperform. First quarter GDP on Thursday will highlight the robustness of the U.S. recovery.
However, it is clear from the price action on Tuesday that investors are not convinced that the Fed is ready to prepare the market for less stimulus. The U.S. dollar traded sharply higher versus the Japanese Yen, Australian and New Zealand dollars, but saw little to no gains against the euro, sterling, the Swiss Franc and the Canadian dollar. Currently, the situation in Europe is grim, but every day, more people are getting vaccinated. The German government believes that as the traction grows, the recovery will as well and, therefore, 2021 growth will be 3.5% instead of its former forecast of 3%.
The Australian and Canadian dollars will also be in focus, with Australian CPI and CAD retail sales scheduled for release. Both countries are expected to report strong data. Canadian retail sales should rebound sharply along with Australian price pressures.