Dollar Boosted by 'Hawkish' Fed Rate Hike

Above: File image of Fed Chair Jerome Powell.

The Dollar surged and stocks fell after the Federal Reserve raised interest rates again and warned significant further tightening would be needed to quell inflation.

The Pound to Dollar exchange rate fell to a new post-1985 low at 1.1219 by Thursday as investors dumped stocks and sought the safe-haven and high-yielding greenback.

The Dollar was stronger across the board, taking an even larger chunk out of the Euro which was down by 1.30% on the day at one stage.

"I still consider this to be moderately USD-positive," says Ulrich Leuchtmann, Head of FX and Commodity Research at Commerzbank.

"After all, things could have turned out differently. Powell had to answer some questions about a hypothetical future pause in the interest rate cycle. Getting that done without supporting those who want to interpret his words dovishly was not easy," he adds.

Above: GBP/USD and EUR/USD at 15-minute intervals. To stay on top of these exchange rates set your free FX rate alert here.

"The US dollar is stronger in the wake of another hawkish FOMC announcement," says Derek Halpenny, Head of Research for Global Markets EMEA at MUFG. "This is frontloading like we have never seen before and gave a very strong signal of the Fed’s determination to get to a restrictive level of monetary policy as soon as possible."

The 75 basis point hike was as expected but the general thrust of the Fed's guidance on the need to hike further prompted the initial bid.

The median dot plot for the end-2022 was raised to 4.4% from 3.4%, this implies another 125bp hikes over the final two meetings.

The 2023 median dot moved some 80bp higher from June's forecast, suggesting the Fed will end its hiking cycle at 4.6%.

Image courtesy of Pantheon Macroeconomics.

"The Fed’s messaging of restrictive rates for longer is evident, as the 2024 median dot was raised from 3.4% to 3.9%, while the newly incorporated 2025 projection suggests only 1.7 percentage points of interest rates will be unwound from next year’s peak over the following two years," says Simon Harvey, Head of FX Analysis at Monex Europe.

The thrust of the Fed update is therefore consistent with ongoing USD strength.

"No let-up in the hawkishness," says Ian Shepherdson, Chief Economist at Pantheon Macroeconomics. "The real interest here is in the new forecasts. The Fed has slashed this year’s growth forecast to just 0.2% (Q4 to Q4) from 1.7%, and the 2023 forecast has been cut to 1.2% from 1.7%."

Regarding inflation forecasts, the Fed raised their 2023 inflation forecast by 0.2 percentage points 0.4pp for next year.

The forecast for 2024 is unchanged at 2.3%, and the first estimate for 2025 is 2.1%, "so no return to target over the next 3-1/4 years," says Shepherdson.

The Dollar is likely to remain supported given the ongoing determination of the Fed to keep hiking.

But looking ahead, Commerzbank's Leuchtmann says past hawkish tones are hard to top.

"It's getting less and less likely that the Fed can push the dollar massively stronger. Those who are betting on USD strength must hope for other factors," he explains.

"Momentum remains clearly in favour of the US dollar as the actions strengthen the prospect of continued tightening of financial conditions," says MUFG's Halpenny.