Fed’s Powell Semiannual Monetary Policy Report will animate markets this week. The testimony begins with Powell reading a prepared statement followed by questions and answers from the Senate Banking Committee members.
Two times a year, this is one of the most important economic events in the currency market. It is especially important this year due to the double-tightening conditions in the United States.
Traders will scrutinize Powell’s speech in search of clues about both the current pace of rate hikes, as well as the effects of the quantitative tightening program.
While the Fed was consistent with the pace of federal funds rate hikes, little is known about the quantitative tightening effects on the economy and the US dollar. By selling the bonds bought under the various QE (Quantitative Easing – Fed bought US Government bonds to ease monetary policy and stimulate the economy) programs, the Fed creates a shortage of dollars in the international system.
The gradual increase under the SOMA (System Open Market Accounts) makes it difficult for international traders to find cheaper dollar by the month.
As previous Fed Chairwoman Yellen said, the Fed intends to make the quantitative tightening process boring as watching an oil painting dry. However, the pressure already builds in some parts of the international markets, with emerging markets being hit the most.
If Powell keeps his hawkish rhetoric, he may just give the green light for another leg higher in the US dollar, mainly against emerging markets currencies like the Turkish Lira or the Brazilian Real.
As for the other currency pairs part of the Forex dashboard, the double-tightening process resulted in a higher US dollar across the board. USD/JPY, EUR/USD, GBP/USD, USD/CHF, they all show one thing this year: a higher USD. Look for the trend to accelerate if Powell keeps the hawkish tone.