U.S. Dollar Sinks on 'Dovish' Powell Speech, but some think Markets Have Got it all Wrong

Above: File photo of Fed Chair Jerome Powell. Image © The White House

The U.S. Dollar was seen sharply lower against its major competitors in the wake of a much-anticipated speech by Federal Reserve Chairman Jerome Powell.

The Fed chair said he and other policy makers continue to see a “solid” outlook for the U.S. economy, while noting that interest rates are "just below" the so-called neutral range.

This prompted a sell-off in the Dollar as it suggests the Fed was nearing the limit it is willing to raise interest rates in the current cycle as the neutral range is interpreted by many to be a ceiling.

In a speech to the Economic Club of New York, Powell said:

“My FOMC colleagues and I, as well as many private-sector economists, are forecasting continued solid growth, low unemployment, and inflation near 2 percent. We also know that the economic effects of our gradual rate increases are uncertain, and may take a year or more to be fully realised.

“While FOMC participants’ projections are based on our best assessments of the outlook, there is no preset policy path.”

Powell said rates today are "just below neutral", emphasising though that there isn't a pre-set path.

The Pound-to-Dollar shot higher by half a percent in the wake of the comments with 1 GBP buying 1.2805 at the time of writing. The Euro-to-Dollar exchange rate is 0.4% higher at 1.1342.

However, a number of economists are concerned that the markets have misread Powell: he isn't in fact being as dovish as the Dollar's reaction suggests.

He still sees a  lot to like about the US outlook, a message to many that would be consistent with hiking again in December.

"He didn't use this opportunity to point out signs of slowing either in the US or globally. So while our forecast is for only 2 hikes next year (well below the last FOMC dot projection) and an ease in 2020, we don't see this speech as quite as dovish as the market seems to be taking it," says Avery Shenfeld, an economist with CIBC.

Ian Shepherdson, Chief Economist at Pantheon Macroeconomics agrees that markets might have misread Powell's comments that rates are just below neutral:

"What the Chair actually said was that rates are "just below the broad range of estimates of the level that would be neutral”.  

"The broad range of estimates of neutral in the September forecasts was 2.5-to-3.5%, and the target range for the funds rate now is 2.0-to-2.25%.

"So the top of the target range is only one hike away from the bottom end of the range, but it remains three hikes from the middle of the range and five from the top.

Moreover, Shepherdson argues estimates of the neutral rate are likely to rise over the next year on the back of stronger productivity growth.

"Mr. Powell’s own views might well be leaning to the dovish side, but he was not, in our view, signalling any impending change in the FOMC’s dots. As always, the Fed ultimately will do what the data tell them to do, and we think the 3.7%-and-falling unemployment rate leaves policymakers very little room for manoeuvre," says the economist.

If this assessment is right, the Dollar sell-off might be unwarranted.

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