Federal Reserve: Pound / Dollar Rises Despite Hawkish Guidance

Above: Fed Chairman Jerome Powell. File image of Jerome Powell © Federal Reserve.

A 'hawkish' Federal Reserve decision to speed up the pace at which it reduces supportive monetary policy was not enough to boost the Dollar, suggesting the market might now be fully priced for the removal of stimulus over coming years.

The Dollar rose on Wednesday after the Federal Reserve (Fed) indicated it could hike interest rates as many as three times in 2022, but gains were soon returned and stock markets went higher in a suggestion that investors feared an even more aggressive policy stance.

This could signal that the market has now fully appreciated Fed hikes are coming and that the bar to further 'hawkish' signals - a driver of Dollar strength for much of 2021 - is now set significantly higher.

The Fed met market expectations and announced a decision to accelerate the pace of tapering from $15BN to $30BN/month from January, allowing the quantitative easing programme to end in March as it ceases to purchase new assets.

The Fed also released data that showed members of the Committee (the FOMC) now anticipated rates would need to rise three times in 2022, up from previous guidance for a requirement of just one hike.

Committee members signal such expectations via a chart where they plant their individual rate expectation levels for coming months and years.

Above: The Fed's latest 'dot plot' chart shows a higher trajectory for interest rates than previously was the case. Image source: U.S. Federal Reserve.

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This 'dot plot' chart showed interest rate forecasts for 2023 were raised while upward revisions for 2024 were made, where the key interest rate now reaches a terminal 2.00-2.25% level.

The Fed had previously expected to deliver up to one hike in 2022, three hikes in 2023 and two in 2024.

But GDP forecasts were lowered a touch, although unemployment expectations were also lowered.

The all-important inflation forecast was raised from 2.3% to 2.7% for 2022. For 2023-2024 the forecast is now at 2.3% and 2.1%, respectively.

"But the Fed still promises to keep the policy rate unchanged until it has reached both its inflation and employment targets. We believe that this comment by Chair Powell, together with already good policy communication, contributed to the minor market reactions after the announcement," says Daniel Bergvall, Economist at SEB.

The Dollar index - a measure of broader Dollar performance rose to a high of 96.90 on the day before falling back to close at 96.32, a loss of a quarter of a percent.

The Euro advanced a quarter of a percent on the day to end at 1.1288 as it extends a period of consolidation.

The Pound to Dollar exchange rate was as low as 1.3171 before recovering to close out the day at 1.3258.

More broadly we can see the Pound-Dollar exchange rate to be consolidating and forming a base following weeks of decline at the hands of the Dollar's broader trend of appreciation:

"The Fed surprised hawkishly in the dots, while doubling the taper pace (to end in March) as widely expected, but the market reaction showed that the meeting was not quite as dramatic as some had been fearing," says Peter Chatwell, Head of Multi-Asset Strategy at Mizuho.

"The rally in equities which, alongside USD FX falling, was a clear sign that the hawks in broader markets had been underwhelmed," he adds. 

The Fed cited "elevated levels of inflation" in its statement for a desire to quicken the pace it pulls back its policy support, blaming supply and demand imbalances related to the pandemic and re-opening of the economy.

Inflation is therefore no longer considered to be transitory in nature.

In response to the developments U.S. interest rate markets proved relatively sanguine.

According to analysis from MUFG, the implied yields on the December 2022 and 2023 contracts were little changed at around 0.7% and 1.4% respectively "signalling that plans for more front-loaded hikes were already well anticipated by market participants".

"It has been more a case of the Fed bringing their own forecasts into line with market expectations. There has been some relief as well that the Fed’s updated plans were not even more hawkish," says Darek Halpenny, Head of Research, Global Markets, at MUFG.

Keeping the Dollar and U.S. rates in check was Fed Chair Jerome Powell's reference to Omicron, saying it posed a source of uncertainty and downside risks to the economic outlook.

Powell also said the first rate hike is unlikely to be delivered as soon as in March.

It would appear that to get the Dollar rally rebooted the market would need to start pricing in more aggressive rate hikes in 2023 and 2024; which for now appears to be a sizeable ask.

"Going forward it still leaves scope for US rate market participants to continue speculating over an even faster pace of rate hikes. However, the price action overnight supports our view highlights that further US dollar gains are going to be harder work going forward given the US rate is better priced now for a more hawkish Fed and the US dollar is trading at more overvalued levels," says Halpenny.