Dollar crashes on less hawkish Fed statement

Important calendar events

• GBP: BOE Official Bank Rate, Monetary Policy Report, MPC Official Bank Rate Votes, Monetary Policy Summary
• USD: Unemployment Claims, Preliminary Nonfarm Productivity, Preliminary Unit Labour Costs, Natural Gas Storage
• Oil: OPEC-JMMC Meetings

USD

The dollar plummeted on Wednesday, following the release of the Fed statement, with the dollar index crashing to 102.5. The US dollar has been rising these past few weeks, surpassing its pandemic high of 2020 and reaching a 20-year record of 103.9, supported by high Fed rate hike expectations. 

Yields also fell across the US treasury curve, with the US 10-year treasury note falling to 2.9%, after reaching 3.1% earlier in the week, for the first time since 2018.

Over the past few weeks, Fed rhetoric has been one of the primary drivers of USD price, as the Fed signalled a faster pace of policy tightening in the US. The outcome of the highly-anticipated Fed meeting on Wednesday disappointed expectations, however, leading to the dollar’s decline. 

The US Federal Reserve raised its benchmark interest rate by 50 base points to 1%, on Wednesday. This is the first time that the Fed has performed such a steep rate hike since 2000. A rate hike of 50 bp, however, had been fully priced in by markets and some market participants were even anticipating a 75 bp rate hike. Markets have been pricing in a total of over 225 base points of additional interest rate hikes this year, with the main Fed rate expected to rise to 2.75%.

More importantly, the ensuing Fed statement was less hawkish than anticipated, with Fed Chair Jerome Powell stating firmly that the Fed is now considering a 75 bs rate hike for the next policy meetings. The Fed’s statement disappointed market expectations, driving the dollar down.

In addition, the Fed’s announced on Wednesday that it would move towards a policy of gradual quantitative tightening. The Fed’s balance sheet has risen to approximately 9 trillion USD during the pandemic and many the US Central Bank to address has decided to start trimming its balance sheet.

Continued Russian hostilities against Ukraine have increased risk-aversion sentiment these past two months, providing support for the safe-haven dollar. The situation between Russia and Ukraine continues to escalate, as Russian President Vladimir Putin makes threats about using nuclear weapons, while he cuts off the gas supply to Poland and Bulgaria. 

Several financial and employment indicators are scheduled to be released for the US on Thursday, including Unemployment Claims, Preliminary Nonfarm Productivity, Preliminary Unit Labour Costs, and Natural Gas Storage. These may cause some volatility for the dollar, although the USD price may still be affected by the outcome of the Fed meeting, as markets will be absorbing Wednesday’s news. 

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EUR 

The Euro has been under pressure by the rising dollar these past few weeks, with the EUR/USD rate trading near the 1.050 level, below a five-year low. On Wednesday however, the currency pair was catapulted to 1.063, following the Fed’s statement that saw the dollar plummet to a one-week low. If the currency pair falls even further, it may find support near the 2016 low around the 1.036 level. The outlook for the pair is still bearish as markets will have time to absorb the Fed’s announcement in the following days, but if the currency pair goes up, it may encounter resistance at 1.118. 

Increased risk-aversion sentiment and hawkish Fed rhetoric have boosted the dollar at the expense of other currencies, with the Euro suffering heavy losses last week after Russian President Vladimir Putin announced that Russia would suspend gas supplies to Poland and Bulgaria. 

Several important indicators were released for the Eurozone on Wednesday, including German Trade Balance, Spanish Unemployment Change, Spanish and Italian Services PMI, French and German Final Services PMI, and Eurozone Final Services PMI. These data provide a measure of economic activity for some of the Eurozone’s leading economies and were overall positive for the EU economy. The PMI data, in particular, are key indicators of economic health and may impact the ECB’s monetary policy. 

The 10-year German Bund yield has risen to 1% this week, for the first time in eight years, as expectations that the ECB will need to increase rates continue to grow. Ecofin and Eurogroup meetings were also held this week, at which the direction of the Eurozone economy was discussed.

Eurozone CPI flash inflation estimates have risen by 7.5% on an annual basis, highlighting the problem of rising energy and commodity prices in the EU. Core CPI estimates rose to 3.5%, further increasing the likelihood of an ECB rate hike in July. Markets are pricing in 3 ECB rate hikes this year, of at least 25 base points each.

The ECB however, has so far been hesitant to raise its interest rates, as the Eurozone economy is still struggling to recover from the effects of the pandemic. The ECB is trying to avert a dangerous economic effect known as stagflation, the mix of economic stagnation and high inflation rates. As the Fed is expected to raise its benchmark interest rate significantly at its policy meeting this week, the Euro remains at a disadvantage from the difference in interest rates.

Many of the Central Bank’s members have repeatedly expressed concern about the high inflation levels in the EU and are in favour of taking immediate steps towards monetary policy normalisation. ECB President Christine Lagarde is in favour of a more dovish stance, however, and has stated that Eurozone inflation is expected to rise in the following months, while economic growth is expected to stall. Even Lagarde however, has shown recent signs of wavering though, as rising inflationary pressures are forcing the ECB to act to drive inflation down. Last week, Lagarde delivered a speech that was considered more hawkish than expected, stressing that the ECB will be following a different route than the Fed, but leaving the door open for a rate hike in July.

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GBP 

The sterling has been under pressure for the past few weeks, falling against the dollar, with the GBP/USD rate falling as low as 1.240 last week. The GBP/USD rate was catapulted to 1.264 on Wednesday though, following the Fed monetary policy meeting. If the GBP/USD rate goes up, it may encounter resistance at the 1.331 level and further up near the 1.341 level, while if it declines, support may be found at 1.241 and further down near the two-year low at 1.206. 

The sterling has been losing ground against the dollar due to the divergence in monetary policy between the Fed and the BOE. Although the BOE started the year with a strong hawkish policy, there are signs that its stance may soften in the coming months, weighed down by a fragile economy. In contrast, the increasingly hawkish Fed policy is boosting the dollar against the pound.

BOE Governor Andrew Bailey has stated that the BOE is walking a tight line between inflation and economic recession and warned of the risks of tightening monetary policy too fast. Recent economic data show that the British economy is sluggish and economic recovery is still a long way off. 

The cost of living in the UK has been increasing, driven primarily by the high cost of energy imports, putting pressure on UK households. Rising commodity prices and import costs in the UK are driving inflation rates higher, with headline inflation reaching 7%. UK inflation has hit a 30-year high and is expected to rise further in the coming months, with a peak rate close to 9% in Q4. Soaring inflation rates in the UK increase market expectations that the BOE will raise its benchmark interest again this week.

The Official BOE interest rate is going to be announced on Thursday, just a day after the Fed announced that it would raise its benchmark interest rate by 50 base points. The Bank of England is expected to raise its benchmark interest rate on Thursday by at least 25 base points, after already performing two consecutive rate hikes in its previous meetings, bringing its rate to 1%. Markets have already priced in approximately six BOE rate hikes this year, although recent BOE rhetoric seems to move towards a more conservative monetary policy. It is also possible that the BOE will keep its interest rate unchanged in this meeting, while a steeper rate hike than 25 base points is considered highly unlikely at the time. 

In this BOE meeting, we expect to see a divergence between Fed and BOE policies, with the Fed moving towards a more aggressive economic tightening by raising its interest rate by 50 bp. The difference between the Fed’s and the BOE’s stance over the past few weeks has been driving the sterling down and propping up the dollar, with most market participants becoming more modest in their expectations of a BOE rate hike. Another important aspect that will likely affect the pound, is the BOE’s potential move towards quantitative tightening. In its last policy meeting in February, the BOE announced that it would move towards a passive tightening of its fiscal policy, by not reinvesting maturing gilts to keep their holdings constant. The BOE retains approximately GBP875 billion of UK government bond holdings and may decide to move towards a more active tightening this week by selling UK gilts, to gradually reduce this amount.

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JPY 

The USD/JPY plummeted to 128.6 level on Wednesday, following the Fed policy meeting. The Yen had plummeted to a 20-year low last week, following the BOJ’s latest monetary policy meeting, with the USD/JPY trading above 131, its highest price in 20 years.  If USD/JPY resumes its ascend, it may find resistance at the 2002 high of 135.3. If the USD/JPY declines, support might be found near the 121.3 level and further down near the 118 level. 

The primary driver of the Yen over the past few months has been the BOJ’s fiscal policy. Last week, the Yen has been pushed down by the persistently dovish stance of the BOJ. Bank of Japan officials acknowledge the impact on the Japanese economy from increased import costs due to the weak yen but persist in following an ultra-easy monetary policy to support the struggling economy. While other countries are moving towards quantitative tightening to return to pre-pandemic fiscal policies, Japan continues to pour money into the economy.

The BOJ announced its main interest rate last Thursday and released an outlook report, detailing the factors that shape its monetary policy. The Bank of Japan continued its ultra-accommodating policy and massive stimulus program. The BOJ also maintained its negative interest rate of -0.10%, in contrast to other Central Banks, which are moving towards a policy normalization after the pandemic and are raising their benchmark interest rates. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down.

The BOJ released a press conference after the conclusion of the meeting, with BOJ Governor Haruhiko Kuroda issuing a dovish statement which pushed the Yen to record lows. Kuroda vowed to continue the bank’s ultra-easy monetary policy, stating that the weakening Yen is not part of the BOJ’s considerations.

The BOJ also stated that it would continue to buy an unlimited amount of Japanese treasury bonds, defending their current low yield. Japan’s 10-year government bond yield is currently close to 0.25%, more than an order of magnitude lower than the respective US 10-year bond, which is offered with a yield close to 2.8%. The large divergence in bond yields makes the low-yielding Yen less appealing to investors than the dollar, pushing its price further down. 

The safe-haven dollar is boosted by continuing Russian hostilities against Ukraine. The Yen is also considered a safe-haven currency but has been underperforming, despite an increased risk-aversion sentiment, and many investors have been doubting its safe-haven status.

This week, May 3-5 are bank holidays in Japan and very few economic events are scheduled for this week in Japan. As a result, the Yen is expected to be influenced mainly by external factors this week, such as the war in Ukraine, the dollar status and the US Fed meeting. 

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Written by:
Myrsini Giannouli

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