Despite Zero Interest Rate Policy Announcement... Dollar Weakness Turnaround Not Easy

Difficulty in Dollar Weakness Reversal Amid US Economic Recovery and Widening Gap with Eurozone
Potential Downward Pressure on Currency Value if Economy and Inflation Recover Faster Than Expected

[Image source=Yonhap News]

[Asia Economy Reporter Gong Byung-sun] Although the U.S. Federal Reserve (Fed) announced it would maintain zero interest rates, analysis suggests it is difficult for the dollar to shift to a weaker trend. This is because the recovery of the U.S. economy is expected to strengthen, maintaining the gap with the Eurozone economy (19 countries using the euro). In particular, uncertainty remains as the Fed hinted at the possibility of normalizing monetary policy.

On the 17th (local time), the Fed announced after the Federal Open Market Committee (FOMC) meeting that it would keep the benchmark interest rate at the current 0?0.25% level and maintain the pace of asset purchases. It also stated that there would be no rate hikes until 2023. Fed Chair Jerome Powell emphasized that although the recovery in the real economy, including employment, is strengthening, the focus should be on confirming actual progress in indicators and considering changes rather than improving forecasts.

There have been claims that the Fed’s measures could lead to a further weakening of the dollar. In fact, after the FOMC meeting, the dollar’s strong trend that had continued since the beginning of the year somewhat slowed down. According to the price-checking site TradingView, the dollar index, which had fallen to 89.209 earlier this year, rose to 91.951 on the 9th. However, after the Fed’s announcement, it also dropped to 91.373 during trading on the 17th.

However, KTB Investment & Securities interprets that a shift to a weaker dollar is difficult. First, the U.S. economic recovery is strengthening. The U.S. is expecting improvements in consumption, excess demand within manufacturing, and easing of economic activity restrictions by implementing additional stimulus measures. Furthermore, demand for services is expected to rise sharply due to the spread of vaccinations.

Additionally, the slow recovery of the Eurozone economy is another factor preventing a shift to a weaker dollar. Currently, Eurozone countries face setbacks in normalizing economic activities compared to the U.S., and they are also lacking in terms of expanding fiscal spending. Even if vaccinations spread, the U.S. may face a similar environment, so the gap is unlikely to narrow.

The possibility of normalizing expansive monetary policy must also be considered. There is uncertainty that interest rates could be raised at any time if inflation concerns increase. Fed officials responded that uncertainty about inflation forecasts has risen compared to December last year, and the dot plot shows that seven members expect rate hikes next year, two more than before.

In particular, if the market reflects this year’s price increases in long-term inflation expectations or if the rise in service prices strengthens, leading to an expansion and persistence of inflation, the Fed may take action to stabilize prices. This is because it needs to demonstrate to the market its credibility in controlling inflation. Nevertheless, KTB Investment & Securities still expects the Fed to induce a downward stabilization of real interest rates, which means a moderate rise in nominal interest rates and expected inflation. However, they added that if the U.S. economy and inflation recover faster than expected or if countries outside the U.S. cannot endure changes by the Fed, downward pressure could increase in terms of the economy and currency value.

This content was produced with the assistance of AI translation services.