It has been an extraordinary week on the economic front.
Inflation & The US Dollar
The positive trend of the US Dollar’s recovery persisted, spurred by ongoing Federal Reserve monetary policies and recent data releases. All eyes, then, are shifting to what the Federal Reserve will say next. Stakeholders around the world are especially looking forward to hearing from US President Donald Trump. Escalating geopolitical tensions, trade war fears and stressed-out risk appetite played their part on the market dynamics across various currency pairs, including XAU/USD and GBP/USD.
The Federal Reserve is currently and very aggressively utilizing Quantitative Easing (QE) to inject liquidity into the financial system. This tactic often leads to a softer US Dollar. The USD has prevailed amidst risk aversion and better-than-expected data. Trade jitters and geopolitical tensions are likely to prevent deeper losses for the XAU/USD. Investors are rushing into safe-haven assets while they figure out this unprecedented uncertainty.
GBP/USD struggled to find traction to the upside. This came a day after the Bank of England decided to hold its policy rate at 4.5%, leading to a small drop. At the same time, USD/JPY was climbing in Asia Friday, getting a lift from those positive market conditions.
Federal Reserve's Monetary Strategies
The Federal Reserve has again been at the forefront of discussions about the economy with its recent decision to continue its policy of Quantitative Easing (QE). By contrast, QE is about increasing the flow of credit in a financial system that is deeply stagnated. Not surprisingly, this process typically leads to a depreciation of the US Dollar. Lately, the markets have been going against that trend, with the USD strengthening even as the Fed continues QE.
During this stage the Federal Reserve halts bond purchasing entirely, or decides not to reinvest by buying new bonds when current ones mature. That strategy has not been fully realized, with the emphasis so far primarily on pumping up the economy and maintaining growth through QE.
US President Donald Trump has added his voice to the ongoing monetary policy debate, urging the Federal Reserve through social media to lower interest rates. This request is consistent with his administration’s goals to boost economic growth while curtailing inflationary pressure.
Impact on Currency Markets
The USD Index, which measures the US Dollar against six major currencies, continued its upward trajectory early Friday, remaining in positive territory on a weekly basis. Positive headlines from the US Department of Labor helped justify this strength. Furthermore, a very positive existing home sales report helped to buoy the outlook.
The Labor Department also reported that there were 223,000 initial jobless claims for the week ending March 15. That’s just shy of the market expectations of 224k. Plus, pending home sales jumped by 4.2% in February, making up for January’s 4.7% decrease. These economic figures have helped create a positive market sentiment towards the USD.
By comparison, EUR/USD had dropped by around 0.5%, finishing in the red on Thursday to close below par for a second day in a row. The European currency has notably struggled against the backdrop of continued overall market volatility and global geopolitical concerns.
Historical advice from John Maynard Keynes on the pitfalls of pursuing national self-sufficiency rings eerily true when applied to our current economic realities. Our childhood hero warned against haste and irresponsibility in withdrawing from the world stage—a timely warning when isolationism pulls on us in the modern interconnected global economy.
"It should not be a matter of tearing up roots but of slowly training a plant to grow in a different direction." – John Maynard Keynes
Market Reactions and Outlook
Or, to put it another way, the currency markets have reacted whimsically to these developments. The Bank of England voted unanimously to hold its policy rate at this level. Consequently, GBP/USD was unable to find traction and continued its drop in value as a result. And perhaps most remarkably, the USD/JPY pair showed great strength. It rose by some 0.4% in the Asian session on Friday, spurred higher by broad bullish sentiment for the US Dollar.
Market participants are if not ravenously focused on next Federal Reserve communications along with President Trump’s speech from the Oval Office. These events are likely to confirm or deny any speculation around where monetary policy direction and economic priorities will lay.
Trade tensions and geopolitical risks continue to cast their shadows over the markets. Investors are nervous, flocking to the safety of low-volatility assets. XAU/USD is expected to find shallow downward pressure as geopolitical risks keep underpinning the demand for gold as a safe haven.