Dollar Struggles in the Face of Fed Policy Uncertainty: XM.com

Written by Raffi Boyadjian, Lead Investment Analyst at XM.com. An original version of this article can be found here.

Pricing for the Fed funds rate in futures markets has been very erratic lately as traders are trying to outguess the Fed on three fronts: skipping a rate rise in June, hiking and then pausing in July, and cutting rates in December.

After the hawkish tilts from Canada and Australia, investors are once again scaling back their bets for a rate cut by year-end.

But one final hike in July or possibly in September is not yet fully priced in. At the same time, there are still sizeable odds of an increase in June.

This probably explains why the U.S. dollar has lost its sense of direction and has been somewhat drifting lower over the past week as investors just can’t seem to make up their minds over what the Fed will do next.

There is a risk that the FOMC is headed for a split vote next Wednesday and so the dollar dilemma may not get resolved so quickly.

Both the Aussie and loonie are trading around four-week highs, while the euro and pound have been able to reclaim the key levels of $1.07 and $1.24, respectively.

For now, it is time for others to shine and unsurprisingly, the Australian and Canadian dollars are leading the advances against the greenback this week.

The Bank of Canada became the second central bank to hike interest rates this week, joining Australia’s Reserve Bank in upping the battle against persistently high inflation. More significantly, Wednesday’s 25-basis-point hike marked an end to the Bank of Canada’s pause period that began in January.

Policymakers in Western economies have been taken aback by the consistent upside surprises in both the inflation and economic growth data.

Even now after the policy mistakes by almost every major central bank over the notion that this surge in inflation will be transitory, policymakers seem to be underestimating the full impact of the price shocks stemming from the pandemic, the Ukraine war as well as the global labour shortage phenomenon.

However, with the RBA and BoC not only stunning markets with their policy responses this week, but also by signalling they may not be done with rate increases, investors have had a major wake-up call ahead of the Fed’s own decision in just under a week’s time.

The yen also firmed against the dollar after Japan revised up its Q1 GDP estimate, boosting bets of a tweak in policy by the Bank of Japan in one of its upcoming meetings.

The Turkish lira on the other hand continues to be pummelled and has lost more than 10% of its value so far this week amid doubts about how President Erdogan plans to revamp his economic policies following his election win.