Forex Analysis & Reviews: 23.03.2022 - Aggressive Fed policy leads...

23.03.2022 01:50 PM

Aggressive Fed policy leads to US dollar strengthening

The pressure on risky assets is gradually returning, as expectations of the US Fed's more aggressive policy are still up in the air. Yesterday, statements of the central bank representatives assured investors they are not going to hesitate with the implementation of a more aggressive rhetoric.

St. Louis Fed President James Bullard said that the tightening of US monetary policy should be carried out at a faster pace, as other ways to stop the upward pressure on inflation will not work. Bullard is one of the most aggressive representatives of the Federal Reserve. He believes that the key interest rate should be above 3% by the end of the forecast period. "The Fed needs to move aggressively to keep inflation under control," Bullard told Bloomberg Television. "We need to get to neutral at least so we're not putting upward pressure on inflation during this period when we have much higher inflation than we're used to in the US," he added.

The neutral rate is the level that neither spurs nor restrains inflation. Bullard estimates the rate at 2%, while the median of his colleagues sees it around 2.4%. Their latest quarterly projections show they see rates rising to 1.9% by the end of this year and 2.8% by the end of 2023.

Bullard is not alone in taking a more aggressive approach. More recently, former US Treasury Secretary Lawrence Summers said that the US Federal Reserve would have to raise interest rates higher than officials currently forecast if it wanted to get inflation back under control. According to Summers, the central bank still seems to be underestimating the severity of price pressures. The risk of a recessionary economy will eventually push the Fed to raise borrowing costs. "Ultimately we're going to need 4-5% interest rates, levels they're not even thinking of as conceivable," Summers said. "They're recognizing that they're behind the curve. They've still got a long way to go."

Last week, the Federal Open Market Committee voted 8-1 to raise rates by 0.25% for the first time since 2018. It was just Bullard who dissented in favor of a half-point hike. Apparently, after thinking about it over the weekend, Chairman Jerome Powell said this Monday that he and his colleagues would be willing to raise rates by half a point at the May 3-4 meeting, but as long as it was necessary.

Asked how quickly the Fed should move, Bullard said "faster is better," adding that "the 1994 tightening cycle or removal of accommodation cycle is probably the best analogy here." From 1994 to early 1995, the Fed, under Alan Greenspan's leadership, raised rates from 3% to 6% and achieved a "soft landing" of the economy with inflation contained. "We came out of the pandemic and we got surprised by inflation," Bullard said. "But now what you have to do is move the policy rate up discreetly a fair amount - not to be too disruptive, but I think 50 basis points should definitely be in the mix," Bullard said.

As for the technical outlook of the GBP/USD pair

To continue the growth of the pound, bulls need to think about how to keep the price above 1.3250, as well as how to break above the 1.3300. In the case of a breakthrough of 1.3250, strong supports are seen only around 1.3200 and 1.3160. It will be possible to talk about the continuation of the bull market only after the price breaks through above 1.3300, which is likely to lead to an immediate jump of the pound to the highs of 1.3340 and 1.3390.

As for the technical outlook of the EUR/USD pair

The geopolitical tension around Russia and Ukraine remains rather high and the prospects of further strengthening of risky assets are gradually fading. Taking into account the aggressiveness of the Fed policy - it is better to bet on the further strengthening of the US dollar. For euro buyers it is necessary to return the price above 1.1050, which may allow continued correction to the highs of 1.1090 and 1.1140. A further decline in the pair will be met by active buying around 1.1000. However, the key support level remains around 1.0960.

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*Disclaimer: The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.