The next Federal Reserve meeting is scheduled for December 14-15, 2021, and the markets are already anxious about what that might bring. High inflation and a tight labour market already incentivized the largest Central Bank in the world to start tapering its asset purchasing, but as some new developments have occurred recently, the stakes are even higher, and the risk of a policy mistake has naturally increased.
Although emerging markets have already started lifting rates, since inflation reached double-digit figures in some countries, the focus remains on the US Dollar, which continues to rise against both developed and emerging currencies.
Fed’s Chair Signaling Potential Faster Taper
Until the Fed meeting, those involved in the forex market have already gotten a hint of what to be from the chair Jerome Powell, during a congressional hearing that took place a few days ago. Perhaps one of the most notable headlines deals with the ditching of the transitory inflation narrative, which triggered a swift response in the market – appreciating USD, lower stocks, and rising short-term Treasury yields.
As inflation becomes a bigger worry for the Fed, the idea of a faster taper has also been floated. Because of that, markets now expect such a move to occur at the December meeting, which will give the Central Bank more air, in case lifting rates is necessary sooner than anticipated.
Omicron variant to dent the outlook?
Adding to the uncertainty related to the Fed’s meeting, the latest coronavirus variant Omicron seems to be some sort of “black swan” event. Higher transmissibility and lower vaccine effectiveness can mean that countries might need to reimpose economic restrictions.
For the time being, researchers are still figuring out whether the variant is that dangerous, which leaves the markets on edge. A risk-on mood favours currencies like the Euro or Sterling, but when a negative headline related to Omicron floods the news, things quickly reverse.
In such an environment, market participants are not eager to gain long-term exposure and that means there will be no strong price directional bias until more clarity is provided.
US Dollar higher – can it start hurting the global economy?
Getting back to the US Dollar, it has already gained substantial ground against its peers since the beginning of the year. The DXY, or the Dollar Index, trades at around 96, an impressive figure, given that it was trading at 90 in January.
Markets have been pricing in a growing dovishness by the Fed and in order to see the Dollar trend further extending higher, some surprises on the upside will probably be required. That’s very unlikely, given financial markets are already defensive, with the VIX reaching 30 for the first time since January.
The December meeting might bring what the markets expect (a faster taper), but at the same time, the developments might be accompanied by the same cautious tone Jerome Powell has used many times. After all, financial conditions will still be very accommodative and the Central Bank will continue to buy assets for another few months.