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Expect US Fed to start tapering balance sheet after 6 months in case of rate hikes in 2023

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Rahul Gupta

Head of Currency Research

19 Jun 2021

The hawkish Federal Reserve outcome came as a surprise to the market participants, not like the traders weren't expecting the tapering, however, they didn't expect the Fed to signal at the June policy meeting. The dollar bulls were anticipating the rate hike hints at the Jackson Hole Symposium, so after the decision, the forex market witnessed high volatility.

The Asian market was the first to react to the tightening news and almost all emerging market currencies slumped, the Indian rupee was no different. The dollar index rallied to a two-month high of 92.007 while the Indian rupee depreciated to 74.2625, level last seen on May 3, 2021. The USDINR 1-month ATM (At the money) volatility has surged to 5.5 percent from an average of 4.5 percent observed since mid-May. Now, the traders fear whether these losses could mark the start of a new era of declines in emerging market currencies, which were vulnerable to speculation the Fed may soon begin winding down its bond-buying program.


The Fed's dot plot suggests a majority of 11 Fed officials pencilled in at least two quarter-point interest rate increases for 2023, that is at least two rate hikes could come as soon as 2023. The market participants were expecting the Federal Reserve to tighten monetary policy in early 2023 as the March had projected no increase in interest rates until at least 2024. Now if the Fed is planning to hike twice in 2023, then it means it will start to tighten its monetary policy much sooner. This means ceteris paribus, we can expect the Fed to start tapering its balance sheet somewhere end of this year (likely December) or early next year. We will get to know about it at the Jackson Hole Symposium due on August 26-28, 2021. Until then, the trend in dollar will be decided by the high frequency indicators.

The Fed believes that the economic data will continue to improve in the coming months, so it has raised its headline inflation expectation to 3.4 percent, a full percentage point higher than the March projection of 2.4 percent and expects the economic growth to hit 7 percent this year. Any upbeat US economic data will increase further bets for an early rate hike, keeping the dollar bulls active, making EM (emerging market) currencies vulnerable. Meanwhile, the rally will be capped on any US Biden's administration plans to push the bipartisan infrastructure deal to support the economy.

But going ahead, the driving force will be the US-China trade conflict under the Biden administration, the tapering speculation compared to US economic recovery and whether US fiscal stimulus will lead to overheating? The USDINR spot pair is following the strength in the US dollar index. It is currently trading at 74.17 which is just above the crucial 61.8 percent Fibonacci Retracement mark of 74.16. Friday's weekly closing was important for more clear direction for USDINR in the coming days.

Sustenance above 74.25 will open doors for 74.50-74.65. However, technically, the pair is trading in an overbought position with the RSI indicator standing at 85.0. If it gives weekly closing near or below 74.0 today then we can see the pair to witness a dip towards 73.90-73.65 and consistent trading below 73.65 will lead the pair towards 73.50/73.45.