J. Powell announced the regulator's decision to start targeting the average inflation rate at around 2.0% as he spoke via video conference during the symposium. Moreover, he will now allow inflation to exceed the 2% mark, so that low inflation will flatten. In our opinion, this action turned out to be a compromise, capable of supporting the demand for risky assets without swaying the markets and putting pressure on the yield on US Treasury government bonds, which, in turn, will put pressure on the dollar.
Why did the Fed decide on targeting inflation at 2%?
Due to their rotation on the current Open Market Committee (FOMC), Fed members who voted have previously set out different inflation targeting levels that ranged from 2% to 2.5%. However, Powell said that the 2% target clearly fits into the desired inflation level formed in the last decade. As we see it, this was a compromise solution to support the recovery of the labor market amid the most stimulating monetary policy for the economy. In fact, the unanimous decision taken by the FOMC will allow the regulator to take all necessary measures to achieve an average 2% inflation rate. It should also be noted that this decision guarantees a long period of low interest rates, which completely excludes Fed's attempts to totally change the monetary rate at any time.
What are the consequences of targeting inflation rate?
In view of this, the stock markets will be in steady demand for company shares. Moreover, this demand will only grow if the US economy and the world as a whole will recover. A guaranteed long period of low interest rates will contribute to this. At the same time, there will be a recovery in demand for US Treasuries, through reducing yields, which are putting pressure on the US dollar in light of Powell's speech yesterday. We believe that the dollar rate will remain under strong pressure in the new reality – a guaranteed period of low interest rates in the wake of inflation targeting, large-scale stimulus measures from the Fed and the US Treasury.
Should we expect a rise in the price of gold in the new reality?
We believe that the regulator's new monetary policy will fully change markets' focus from protective assets that do not bring interest income, which include, gold to company shares, which will push up stock indices both in Asia, Europe and North America. The same fate is expected in silver.
Will the dollar fall again?
In the context of the new reality, the dollar is likely to show weakness against major currencies due to specific measures aimed at stimulating the recovery of the US economy, but at the same time, its strongest decline is not expected to continue. Much of its recent decline has already been factored into prices in the wake of expectations of the Fed's decision to target inflation. We believe that its fate will fully depend on the incoming data of economic statistics on the US economy. To simply put it, the dollar will decline if the values of important economic indicators show a generally positive trend. At the same time, if they show values worse than expected, the dollar rate will then at least balance in sideways ranges, primarily to major currencies.
Conclusions
The Fed's decision to target inflation is indeed important and for long-term solution. These measures will weaken the dollar over time, contributing to the growth of demand for company shares, while lowering investor's interest in non-interest bearing assets - gold and silver. However, the decline rate will still be connected to the incoming US economic statistics and the process of national economic recovery.
Forecast of the day:
The AUD/USD pair is gaining support amid Fed's decision to target inflation, which points to potential weakness in the US currency. In addition, the resumption of the trade negotiation between Washington and Beijing contributes to the positivity of AUD. Thus, we can expect the price to break the 0.7270 level, which opens the way to rise first to the level of 0.7320 and then to 0.7385.
The USD/CAD pair fell below the strong support level of 1.3130 amid fundamental weakness in the US dollar. Thus, we expect the pair to continue falling to 1.3030.
