Dollar Retreats after Fed's Powell Says Financial Conditions in Sweet Spot

"It's good that we have seen a very strong labor market, but at the same time we're seeing wages moderating" - Federal Reserve Chairman Jerome Powell. 

File image of Jerome Powell © Federal Reserve

The Pound to Dollar exchange rate rallied late on Tuesday after Federal Reserve Chairman Jerome Powell said U.S. financial conditions have adjusted themselves into what is something of a sweet spot for the bank since last Friday's blockbuster non-farm payrolls 

Dollars were sold widely after Chairman Powell told the Economic Club of Washington that ongoing increases in interest rates remain necessary and that a restrictive level of rates will be maintained over a "significant period" but that financial conditions are now in a much better place than they were. 

This is after the non-farm payrolls report for January cast the U.S. labour market in a robust light and prompted Fed Funds rate futures to price-in a 5% to 5.25% interest rate peak that is in line with the December Federal Open Market Committee forecasts.

"It's good that we have seen a very strong labor market, but at the same time we're seeing wages moderating," Chairman Powell told David Rubenstein, President at the Economic Club of Washington and a former colleague at The Carlyle Group.

"Wages are still very, wage increases are still very high, but wage increases have come down," he added.

Above: Initial reaction of Pound to Dollar rate shown at 15-minute intervals alongside USD/CAD, EUR/USD. Click image for closer inspection. 

Chairman Powell cautioned that it's likely to take "until into next year" before inflation falls back near to the 2% target and warned that Fed policymakers could point interest rates even higher if the disinflation process currently underway is interrupted by a renewed upturn for inflation in the interim.

"So if we continue to get, for example, strong labor reports or higher inflation reports, it may well be the case that we have to do more in rate hikes and raise rates more than it's priced in," he said.

Holding up the return of Personal Consumption Expenditures inflation to the 2% target are price increases in the non-housing part of the services sector - the core domestic economy in other words - and "there remains a long way to go" in order bring it down from the most recent 5% level.

But Powell was also sanguine about financial conditions including bond yields and declining Dollar exchange rates. 

There were also choice words in relation to the latest congressional clash over the notorious U.S. government debt ceiling, which has recently led the U.S. Treasury to resort to "extraordinary measures" as a means of maintaining day-to-day government spending. 

Day-to-day government spending includes the payment of wages and salaries for a vast army of civilian workers who face the risk of furlough if the federal government is forced to choose being paying workers' wages and rolling over the nation's debts. 

"This can only end one way and that's by Congress voting to raise the debt ceiling so that we can pay all of our bills," Chairman Powell said on Tuesday.

Source: Goldman Sachs Global Investment Research. Click image for closer inspection. To optimise the timing of international payments you could consider setting a free FX rate alert here.

"No one should think the Fed has the ability to shield the financial markets or the economy from the consequences if we don't," he added.

Tuesday's remarks and last Friday's payrolls report came just days after the Fed Funds rate was lifted by 25 basis points to 4.75% in a decision that Chairman Powell said would likely be followed by something like "a couple" more of the same kind of increase.

Two more quarter percent increases would lift the Fed Funds rate to 5.25%, in line with December's Federal Open Market Committee forecasts, meaning the outlook for Federal Reserve interest rates may already have been priced as close to perfection as is possible for the time being.

"If a string of upside data surprises in the US were to be realized, then market pricing for terminal rates could soon move higher again, which should benefit the Dollar," writes Sid Bhushan, an economist and FX strategist Goldman Sachs, in a Tuesday research briefing. 

"Indeed, the move higher in the last couple of sessions (after Friday’s February 3 NFP) has been notable. In contrast, currencies such as EUR and GBP may have headwinds in the near term if the market moves to price the ECB and BoE's desire to slow the pace of hiking," he adds.

Above: Pound to Dollar rate shown at daily intervals alongside USD/CAD, EUR/USD. Click image for closer inspection.  (If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.)