Monetary policy is incredibly loose in the US. Record-low interest rates paired with a second round of quantitative easing, have made the dollar a far less appealing prospect to investors. Now, in the past few sessions, noises coming out of the US central bank have started to change.
Several Federal Reserve policymakers have recently given indications that the Fed's second round of quantitative easing (QE2) will end in June. Some have hinted that QE2 could even be cut short before its scheduled June end-date, whilst others have remained coy – stating that they will assess economic conditions and the suitability of the policy closer to the time.
To clear up any confusion, US policymakers have all voted unanimously to maintain QE2 due to a convention of solidarity within the Fed. However, there are quite clearly differing opinions within the group. This contrasts with the situation in the BoE where we currently have a 6:3 split in favour of those voting to keep interest rates unchanged.
The dollar has underperformed all year; largely due to this loose monetary policy approach from the Fed. However, hawkish comments have boosted the greenback in recent sessions, pulling it up from multi-month lows against both the pound and the euro. So what are the long-term implications of this shift in rhetoric? Well, the US economy is looking in a significantly stronger positions than that of the eurozone and the UK. But crucially, the markets are not so interested in economic fundamentals at present; rather they remain focused on prospect interest rate differentials. .
Whilst comments made about curtailing QE2 have been dollar positive, the Fed has made no indications that it will raise rates this year. We can therefore only assume that it intends to tighten policy in early 2012. By contrast, both the ECB and the BoE are expected to raise their base interest rate twice - or even three times - in 2011, and for this reason we can only see the dollar underperforming, holding on to its steady downtrend over at least the medium term.
Richard Driver
Analyst – Caxton FX
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