The U.S. Federal Reserve's Open Market Committee (FOMC) meetings on July 25, July 26, Sept. 19 and Sept. 20 will be critically important for global markets. We may finally get to know to what extent the messages of Fed Chair Yellen and other Fed officials on accelerating a monetary contraction will be realized.
In the last meeting on June 13 and June 14, the Fed made public that it will shrink its balance sheet by $1.65 trillion by 2020, starting with $10 billion in the first three months, $20 billion in the next three, followed by $30 billion and $50 billion after that, as monthly reduction steps.
In line with this, markets cannot foresee if these steps will begin at the beginning of autumn 2017, at the end of 2017, or after the beginning of 2018. However, from the moment it starts, while the cost of debt in dollars will slightly increase, we will observe an effect toward capital outflow, especially from developing economies.
This will have an influence on the currencies of developing countries, including the Turkish lira. For this reason, this issue will be determinant of whether we will pass autumn with a dollar-TL exchange rate around TL 3.5o or around TL 3.7o.
The reports from the last FOMC meeting show that they could not reach an agreement on when exactly the balance sheet reduction will begin. Some officials though have stated that it would start in a few months' time.
Yellen's presentations on July 12 and July 13 showed markets that the Fed is still very wary of the steps it was planning to take. This caused the euro to gain against the dollar. In addition, it will raise tensions in the global markets if Fed decides in mid-September to reduce its $4.5 trillion balance sheet. However, there can be little doubt that the steps taken by the Fed will be the only ones determining the dollar's value.
Amid all these developments, another issue influencing the dollar's value is the turmoil caused by U.S. President Donald Trump in internal and foreign politics. Hardly a day goes by without any controversial development regarding Trump. On one hand, the allegations of ties between Trump, his family and his team with Russia during the presidential campaign, and on the other, the healthcare bill that cannot get passed the U.S. Congress and the discussions on initiating an impeachment process against Trump.
Aside from the debates on Trump, the fact that U.S. inflation is not rising as expected and indicators such as the economic activity, excite discussions on whether if the Fed can realize the monetary contraction to its expected levels.
Nonetheless, with a hunger to invest in global markets, the growing stock bubble, and the economic risks caused by asset prices, it seems the expectations that Fed will start shrinking its balance sheet again in autumn, will not fall off the agenda.
Euro continues its rise with Draghi
As 2015 and 2016 were coming to an end, the leading financial institutions of the world insistently shared their predictions twice, with the global markets that the euro-dollar parity will experience a serious fall. This is why most of the investors have positioned themselves according to the expectation that in the beginning of 2017 that the euro-dollar parity will first reach the $1.08 to $1.04 band as of mid-2017 and then toward the end of 2017 to $1.04 to $1.
Despite all these predictions, since spring, the fact that the parity first reached $1.04-$1.08, then $1.08 to $1.12, and today, $1.1 to $1.16, has surprised global markets.
As much as the uncertainty caused by Trump, the effects of the positive signals in EU economies and some great policies by the ECB should not be disregarded. The statements and determination of the ECB's President Mario Draghi keep the euro strong.
At a press conference following the ECB meeting last Thursday, Draghi said that there will not be any changes in interest rates or asset purchase program.
He said that the monthly asset purchases worth 60 billion euros will continue with the same interest rate at least until December.
Draghi emphasized that for the recovery of prices and wages (inflation) in EU economies, they will have to wait before going through certain stages to reach the ECB's targets. Inflation in the Eurozone decelerated by 0.1 percent to hit 1.3 percent in June when compared to that of May.
The ECB aims to keep this ratio close to 2 percent. On the other hand for the services sector, the locomotive of the 19-member bloc, this ratio went up to 1.6 percent.
Draghi's statement after the ECB interest rate decision drove parity down to $1.148 from $1.1565, in the first 45 minutes, then to $1.1645 over the next three hours.
If the uncertainty caused by Trump continues at this pace and the Fed does not decide to contract its balance sheet at the September meeting, we should not be surprised to see a move to the $1.16 to $1.20 band in euro-dollar parity.