Analyst Views on the US Dollar after Federal Reserve Stands Pat in May

-USD weakens following in-line Federal Reserve rate decision.

-Federal Reserve claims "mission accomplished" on inflation target.

-Analysts forecast June hike but remain divided over USD outlook.

© The White House

The Dollar weakened broadly Thursday as markets responded to the May Federal Reserve interest rate statement, which saw policymakers claim "mission accomplished" on their inflation target while declining to provide any strong signal of when the next interest rate rise is likely to come. 

Federal Reserve rate setters said Wednesday they expect inflation to "run near the Committee's symmetric 2% objective over the medium term, which marks a step change from their earlier forecast that inflation would "move up in the coming months."

This comes after both headline and core measures of US consumer price inflation were both reported above the 2% target for March, while the Fed's preferred personal consumption expenditures measure of prices also registered at exactly 2%, meaning the central bank has now met its inflation target after years of undershooting it. 

The Dollar had topped the leader board of developed world currencies since late April when 10 year US bond yields broke above the 3% threshold, marking a multi-year high. This was due to fears over the increasing supply of Treasury bonds in the market and expectations the Federal Reserve may soon signal a faster pace of rate hikes for the years ahead. 

However, the greenback weakened broadly during the overnight session as markets weighed the contents of the statement and any likely impact on expectations for further rate rises through the rest of the year. One thing that is for certain is the May statement was less hawkish than the minutes of the previous FOMC meeting suggested policymakers might have been feeling. 

Then, back in March, the Fed hinted that it may step up the pace at which it is withdrawing stimulus from the economy during the quarters ahead, saying;

"Several participants expressed the judgment that it would likely become appropriate at some point for the Committee to set the federal funds rate above its longerrun normal value for a time. Some participants suggested that, at some point, it might become necessary to revise statement language to acknowledge that...monetary policy eventually would likely gradually move from an accommodative stance to being a neutral or restraining factor for economic activity."

As things stand, markets are looking for just two more interest rate rises from the Fed in 2018, which would leave the top end of the Federal Funds rate at 2.25%. This means a total of three rate rises for the year overall because the FOMC already hiked its cash rate once back in March.

However, traders have also begun to flirt with the idea of a fourth rate hike in 2018, which has seen overnight index swaps markets put the midpoint of the December 19, 2018 Fed Funds rate at 2.23%. That means the top end of the Fed Funds range (1.75%) is currently seen around 2.35% at year-end.

Not all analysts or economists have bought into the faster-Fed and resurgent Dollar story, instead choosing to view recent price action as a temporary correction within an overall downtrend, and commentary following Wednesday's rate decision underscored this division.

Analysts give their views below on what Wednesday's statement likley means for the outlook for US interest rates and the Dollar. 

At the time of writing the US Dollar index was quoted 0.26% lower at 92.47, setting the greenback up for its second day of losses.

The Pound-to-Dollar rate was 0.24% higher at 1.3604 while the Euro-to-Dollar rate was 0.33% higher at 1.1989.

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Analyst Reactions:

Antje Praefcke, analyst, Commerzbank 

"In the end it was not a major surprise for the market that the Fed left the key rate unchanged at the meeting without a press conference but made positive comments on the outlook and further rate hikes. The market will have to get used to the fact that in order to prevent an economic overheating interest rates in the US will continue to rise and that the Fed’s target corridor will have reached 2.25-2.50% by year-end."

"As a result the argument of rate differentials that I first mentioned in mid-April will become increasingly relevant for the FX market - both for the industrialised nations and for the Emerging Markets."

"As a consequence economic data is likely to become more important again. And the data might support USD again ahead of the weekend and cement EUR-USD in the area of 1.20 for now."

Lee Hardman, currency analyst, MUFG

"The US dollar has softened modestly following the release of the policy statement from the latest FOMC meeting. There has been some disappointment that the Fed’s updated statement did not prove more hawkish than expected. As a result, it has failed to reinforce the US dollar’s current sharp upward momentum."

"The Fed’s newly updated emphasis on the symmetrical nature of their inflation goal appears intended to signal that they will not overreact to a modest inflation overshoot. As a result, it should help to dampen building expectations for the Fed to announce plans for an even faster pace of the rate hikes in the year ahead."

"Overall, the Fed still appears comfortable to stick to plans for “further gradual” rate hikes, which were announced at their previous meeting in March. Some of the upside risks for US yields and the US dollar have now diminished."

"It helps to support our view that the current US dollar rally is unlikely to prove sustainable beyond the near-term. The US rate market already appears reasonably priced for two to three more hikes this year."

Andrew Hunter, US economist, Capital Economics

"The description of the inflation target as “symmetric” could be interpreted as a sign that officials will tolerate inflation rising modestly above 2% over the coming months. But we suspect that they will be wary of the risks of a more significant overshoot."

"In three-month annualised terms, core PCE inflation was 2.6% in March, near a decade high. (See Chart 2.) Producer price inflation is surging. There are also signs that the tightening labour market is finally feeding through to stronger wage pressures."

"The upshot is that we continue to expect three more 25bp interest rate hikes this year and two more in the first half of 2019, with the next move coming in June. The markets have largely come round to this view."

"Where we still differ from the consensus is in expecting that, as the fiscal boost fades and higher interest rates start to take their toll, an economic slowdown in the second half of 2019 will prompt the Fed to back away from further tightening and eventually to reverse course."

Royce Mendes, economist, CIBC Capital Markets 

"If one word stands out in the text, it's the reference to the committee's "symmetric" 2% inflation objective. It's likely that PCE runs a little hotter than 2% over the remainder of the year, but policymakers appear to be trying to tamp down expectations that such a run would warrant a materially faster pace of rate hikes."

"Today's announcement didn't do anything to forewarn that a rate hike was imminent in June, but we still see accelerating growth readings as justifying another move then. The lack of any firm commitment to a near-term rate hike has so far seen yields move lower and the dollar depreciate."

Marvin Loh, senior global markets strategist, BNY Mellon

"The most important acknowledgement was that inflation is now expected to run near its symmetric 2% objective over the near term. The FOMC also continued to see market-based measures of inflation remaining low, while survey measures of longer-term inflation measures remained unchanged."

"Ultimately, things are moving as planned, and the Committee’s base case for above-trend growth continues to support its projection for two additional hikes this year. June remains the likely target date for the next hike, with futures pricing in over 90% odds of that event."

"These odds increased aggressively over the past month and reflect a Fed that is behind the curve. At the moment, we don’t think that data yet supports a more aggressive push by the FOMCand we maintain a total of three hikes in 2018 as our base case."

Rhys Herbert, senior economist, Lloyds Bank

"Overall the message is still that the FOMC expects to make “further gradual increases” in policy rates. To emphasise that policy will still only be tightened gradually the statement now notes that the inflation target is “symmetric”. This may be an indication that the Committee will not react aggressively to inflation running a bit above target for a time."

"Nevertheless, what exactly is meant by ‘gradual’ may be shifting. The FOMC’s March forecast showed the Committee almost evenly split over whether to hike rates three or four times this year, so the ‘hawkish’ changes to the statement may indicate that a majority now favour four hikes. However, there is no suggestion of an intention to significantly pick up the pace at which rates are being raised."

Anders Svendsen, economist, Nordea Markets  

"Fed raised rates in March and the median voter signalled two more hikes this year. We have a baseline forecast of three further hikes this year, and the Fed also sees risks clearly tilted towards three. Only one member needs to change his/her view for that to happen. If the economy develops as expected a hike in June will be most likely be delivered and there is a good chance that the rate path then will signal a total of four hikes this year.

Josh Nye, economist, RBC Capital Markets

"Given the economic backdrop, it wouldn’t have been difficult for the Fed to justify a rate hike at today’s meeting...But honoring their guidance that rates will rise only gradually, the Fed opted against back-to-back hikes and left monetary policy unchanged."

"We think the aforementioned arguments will prompt a rate increase at the next meeting on June 13. The few tweaks in today’s statement didn’t provide an explicit signal in that direction, but the Fed arguably didn’t need to with markets already almost fully priced for a move in June."

Ian Shepherdson, chief US economist, Pantheon Macroeconomics

"The Fed is telling markets that it won't over-react to a run of higher numbers, just as it didn’t over-react to the run of five straight downside surprises last year. The statement notes, as usual, that market-based measures of inflation expectations remain low, with little change in survey-based measures."

"Economic growth, meanwhile, is "moderate", as in March, though business capex has been rising "strongly”. The March line that the "outlook has strengthened in recent months” has been dropped; no surprise. Growth has accelerated, but it isn’t accelerating right now."

"No worries of sustained slowing, though, and the focus is on inflation risks. But the Fed is trying very hard to give the impression of not being worried. We still think the fourth dot for this year is coming, but more likely in Sep than June."

Analyst Previews: 

Kit Juckes, chief FX strategist, Societe Generale

"This evening's FOMC has neither updated projections nor a press conference so the most excitement we can hope for would be from recognition that inflation is now close to the 2% objective. Or they could hike rates, which really would be a big surprise. Otherwise, the focus moves on to the jobs data on Friday."

"I don't see why either bond markets or the dollar should react to the FOMC much, but from here on it is a battle between pressure on short T-note positions and short USD ones. The sooner the former are squeezed out, the sooner position-squaring support for the dollar will ease."

Derek Halpenny, European head of research, MUFG

"Momentum and positioning look to remain key at present as the dollar stabilises following sustained strength across all G10 currencies. The shift back to greater focus on relative macro-economic fundamentals is likely to continue today with the conclusion of the FOMC meeting."

"There is real reason for the FOMC to believe wage growth may be strengthening as the labour market tightens further. The stand-out piece of information will be the ECI data and the 2.9% annual growth in private sector wages and salaries – the strongest since Q3 2008. That may well encourage the FOMC to convey some greater degree of confidence in suggesting that it is closer than ever to achieving its dual mandate since the Great Financial Crisis."

"We remain unconvinced that this will now spark a continued rally for the dollar. The jump in core PCE inflation is no surprise and was fully anticipated by the market and no doubt the FOMC. Secondly, the FOMC’S track record on hitting its 2.0% goal has been appalling since the GFC. In the last 10 years, the 2% goal has been hit in just five months."

Viraj Patel, FX strategist, ING Group 

"Unless we get an out-of-character hawkish signal in the statement – one that explicitly alludes to a faster pace of tightening than previously anticipated – then we think today’s FOMC meeting runs the risk of disappointing markets."

"It’s not unusual in the latter stages of a Fed tightening cycle to see a narrow window of $ strength ahead of an FOMC meeting; but the reality of a gradualist central bank more often than not leads to a ‘buy the hawkish Fed rumour, sell the gradual Fed fact’ type of price action in the $."

"If history were to repeat itself, then we would expect the USD bear trend to resume after today’s FOMC event. Should the USD’s momentum continue after a status-quo Fed statement – then this correction may be less fickle than we originally thought."

"While the White House has been driving the agenda for much of 2018 – strangely, today’s ‘non-event’ Fed meeting could hold the key to global markets over the next few months. Over to you, Chair Powell."

Ben Randol, FX strategist, Bank of America Merrill Lynch

"We do not expect any major changes to the policy statement other than to mark the language to the incoming data. Specifically, given the recent rise in core inflation, we think the FOMC will acknowledge that inflation is progressing smartly toward its 2% target although it still runs below its objective."

"Otherwise, we expect the Committee to reaffirm their outlook for the economy and the path of policy from the previous statement, settingup the Committee for a rate hike at the June meeting. The FOMC will only release a policy statement as there is no press conference or an update to the Summary of Economic Projections (SEP) scheduled for the meeting.

"The dollar has begun to rally as we expected. We think this will likely continue as cyclical fundamentals have turned in favor of the USD."

Mazen Issa, FX strategist, TD Securities

"With no projections or press conference, today's Fed decision is likely to pass with little fanfare. A temporary shift away from global convergence to divergence should leave the USD supported however, and may place greater emphasis on the rates backdrop. Here, we think it is worthwhile to monitor the Treasury refunding announcement, which is expected to announce sizable issuance."

"On the one hand, additional supply may pressure yields higher and further support the USD in the short-term. On the other, it may re-ignite the twin deficit debate that is expected to anchor the USD lower in the long-term. For now, we think the former will be more relevant given the cooling in the global reflation trade. 92.55 may act as the next hurdle of resistance for the DXY, before signaling a topside extension risk towards 94."

Thu Lan Nguyen, analyst, Commerzbank

"The [US] economy is doing well, the labour market has been cleared and now inflation in the US has also virtually reached the 2% target. The European economy on the other hand is beginning to flag (latest GDP data for the euro zone will be published today) and inflation is showing no signs of rising towards the central bank’s target. It is therefore hardly surprising that the US dollar has been able to continue its winning streak experienced over the past two weeks."

"The Fed meeting tonight bears the potential of providing further tailwind to the dollar. In our view the US central bankers are likely to raise their key rate more quickly this year than their forecasts suggested. The market meanwhile has so far “only” fully priced in the two rate hikes the Fed has so far signalled until year-end and is only just starting to expect one more for this year."

"Our US experts expect that this year alone there will be a total of three more rate steps. It is possible that the Fed might not yet provide an indication of more rapid rate hikes in today’s meeting, but we expect that it will do so over the coming months; which in turn confirms us in our expectations that the rate expectations will rise further and that the USD recovery will continue as a result."

John Hardy, chief FX strategist, Saxo Bank 

"The big dollar is charging hard into tonight’s FOMC meeting, where the bar is now much higher for the Fed to surprise on the hawkish side. Tonight’s and this week’s close are important for the next steps."

"A couple of forecasters are even looking for a hike at tonight’s meeting, a step/indication we doubt very much the Fed would like to make, even if Powell would like more flexibility in moving at non-press conference meetings. Beyond this December, the market remains sceptical that the Fed will reach its forecasts as curve expectations are largely flat beyond the December meeting."

"The nature of the Fed’s statement this evening aside, the backdrop is devilishly difficult heading into the FOMC – is this a classic buy the rumour and sell the fact on the USD even if the Fed is relatively hawkish, or will the still-tremendous pile of USD speculative shorts feed an additional squeeze?"

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