Euro / Dollar Gains Short-term Relief as Fed Liftoff Draws Profit-taking

• EUR/USD attempting recovery, could rise further short-term
• After Fed begins to lift rates but USD eases on profit-taking
• Dot-plot matches market view of 2022 & much of next year
• But balance sheet unwind ahead & Fed may move faster yet
• EUR/USD facing multiple resistances on approach of 1.1150

Above: File Image of Chair Jerome Powell. © Federal Reserve

The Euro to Dollar rate built further on an overnight recovery Thursday after the Federal Reserve (Fed) took the first step toward a tightened monetary policy, which appeared to trigger further profit-taking in many U.S. exchange rates.

Europe’s single currency climbed against most major counterparts on Thursday after rising back above the recently-lost 1.10 handle, while Dollar exchange rates eased lower almost across the board following the Federal Reserve’s widely expected decision to begin lifting its interest rate.

"By the end of this year, broadly people are at or close to, or in some cases above their estimates of the longer-term neutral rate," Chairman Jerome Powell said of the latest Federal Open Market Committee (FOMC) dot-plot of policymakers’ projections for interest rates.

"The way we’re thinking about this is that every meeting is a live meeting, and we’re going to be looking at evolving conditions and if we do conclude that it would be appropriate to move more quickly then we’ll do so," Chairman Powell also said.

The Fed Funds rate was lifted to between 0.25% and 0.5% while the bank signalled that it will likely match market expectations for the benchmark to rise as far as two percent this year, and also indicated that it could potentially exceed expectations for 2023.

Above: Euro to Dollar rate shown at 4-hour intervals with Fibonacci retracements of late February decline indicating possible technical resistances. Click image for closer inspection.

• EUR/USD reference rates at publication:
  Spot: 1.1047
• High street bank rates (indicative band): 1.0660-1.0740
• Payment specialist rates (indicative band): 1.0950-1.0980
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• Set up an exchange rate alert, here

Analysts and financial markets had already broadly anticipated such an outcome from the Wednesday decision, however, and this may have been a factor driving the U.S. Dollar’s response in the overnight hours and early on Thursday.

The March set of policymakers’ projections indicated that U.S. interest rates could rise to anywhere between 2.5% and 3.25% in 2023, although Chairman Jerome Powell said the FOMC would be prepared to move faster this year and next if inflation does not follow the path anticipated.

“We expect though, and particularly with the effects of the war but also with the data we’ve seen so far this year, we expect inflation to remain high through the middle of the year, to begin to come down and then come down more sharply next year,” he told reporters in a press conference.

Previously, the Fed had expected U.S. inflation to top out some time in the first quarter of 2022 before beginning to decline gradually later in the year.

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Should U.S. inflation eventually prompt a decision to accelerate the pace at which interest rates are lifted then it might be likely to upend financial market pricing in favour of a stronger U.S. Dollar, which would almost inevitably come as a headwind for the Euro-Dollar exchange rate.

“We haven’t made any decisions on front-end loading or going steadily through the year. As I mentioned, if you look at the SEP a good number of participants do see more than seven rate increases this year,” Chairman Powell said on Wednesday.

“We’ll be looking at the inflation outlook and making a judgement. Each meeting is a live meeting and if we conclude that it’ll be appropriate to raise interest rates more quickly then we’ll do so,” he told the press conference.

In the meantime, there are also potentially upside risks for the Dollar and eventual downside risks for EUR/USD stemming from the Fed’s plan to begin the process known as quantitative tightening.

Above: Euro to Dollar rate shown at daily intervals with Fibonacci retracements of early February decline indicating possible technical resistances, and shown alongside spread or gap between German and U.S. 02-year government bond yields. Click image for closer inspection.

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Quantitative tightening will eventually see the bank begin to shrink its $8.9 trillion balance sheet by ceasing to reinvest predetermined amounts of government bonds and other assets as they reach their maturity dates.

The process is something that would withdraw ‘liquidity’ from the financial system as the Fed shrinks its balance sheet, resulting in a “tightening of financial conditions” that is controlled using predetermined “caps” on the value of balance sheet assets that are retired each month.

“At our meeting today we made excellent progress toward agreeing on the parameters of a plan to shrink the balance sheet and I would say we’re now in a position to finalise and implement that plan so that we’re actually beginning to run-off at a coming meeting,” Chairman Powell said on Wednesday.

“That could come as soon as our next meeting in May. That’s not a decision that we made but that’s how well our discussions went in the last two days. We’ll be mindful of the broader financial and economic contexts when we make the decision on timing. We always want to use our tools to support macroeconomic and financial stability and we want to avoid adding uncertainty to what’s a highly uncertain situation already,” he added, in the press conference.

Above: Euro to Dollar rate shown at daily intervals with Fibonacci retracements of June 2021 decline indicating possible technical resistances, and shown alongside spread or gap between German and U.S. 02-year government bond yields. Click image for closer inspection.