Deutsche Bank believes that if the Federal Reserve System (Fed) of the United States focuses on reducing its balance sheet rather than raising interest rates to tighten monetary policy, it will be an obvious negative factor for the US dollar:
Last month, the Fed, under the new president Kevin Warsh, shifted to a more stringent policy. At least half of the 18 members of the FOMC still expect at least one interest rate hike this year. At the same time, the Fed is also discussing the reduction of the money supply. The regulator's balance currently stands at about $6.7 trillion, down from a peak of around $9 trillion in 2022:
Georg Saravelos, head of currency strategy at Deutsche Bank, points out that the experience of the Bank of Japan shows that reducing the balance sheet does not necessarily strengthen the national currency. Despite the Bank of Japan rapidly implementing quantitative tightening in recent years, the Japanese yen continues to remain historically weak:
According to Saravelos, tightening the balance sheet can only support the currency if it is accompanied by an increase in short-term yields. Otherwise, the impact on the dollar could be limited or even negative:
He also warns that further reductions in the Fed's balance sheet could create conflicts with the US administration, as the latter is interested in keeping long-term government bond yields low. Such a situation has already been observed in Japan, where the independence of the Bank of Japan periodically becomes a topic of political discussion:
Deutsche Bank also notes that the Fed's share in the US government bond market is not particularly large, so the bank is not confident that further reductions in the balance sheet will be an effective tool against inflation. If, however, the Fed emphasizes balance sheet reduction instead of raising interest rates, it will be a clear negative signal for the US dollar, according to the bank:
According to the latest data, the US dollar index (DXY), which measures the dollar's exchange rate against a basket of six major currencies, stood at 100.77:
