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Dollar Holds Steady as Powell Laces Forecast Cuts with Optimism

  • Kathy Lien
  • 20 December 2018

Daily FX Market Roundup 12.18.2018

 

On paper, it should be no surprise that the dollar rallied after a Federal Reserve rate hike but today's gains were unexpected for a few reasons.First, most investors were looking for Fed Chair Powell to be dovish and when he lined his comments with optimism, the dollar rose. Secondly, the dollar rallied despite the fact that 10-year Treasury yields dropped to an 8 month low. Rate hike expectations also declined with the market now pricing in a greater chance of a rate cut than a rate hike in 2020. All of this combined with downgraded GDP and inflation forecasts should have driven the greenback lower but instead, the dollar rallied because the tweaks to the policy statement weren't dovish enough.

 

Investors had braced for the worst - from no rate hike to dissents and a change in the risk assessment.And while there were subtle tweaks in the statement and lowered growth and inflation forecast, these changes were not as significant as the market had hoped. The same was true of Fed Chair Powell's comments - he made it clear that nothing is predetermined and everything is data dependent but he also said the sharp decline in US equities and the tightening of financial market conditions has not fundamentally altered their outlook. The Fed still plans to raise interest rates next year and most policymakers expect the economy to grow. Compared to the rest of the world, they could be one of the very few central banks tightening in the first half of 2019 and this possibility lent support to the dollar, preventing the currency from falling further. However the bond market is usually right and it will be difficult for the dollar to sustain its gains if yields continue to fall.

 

At the end of the day, even though the Fed is holding onto their positive outlook and putting on a brave face, the main takeaway is that they will only raise interest rates again if data improves.So the path of least resistance for the dollar is lower with EUR/USD likely to find its way back above 1.1450 and USD/JPY head for a move below 112.

 

Here are the Top 10 Takeaways from Dec FOMC

 

1. Raises interest rates by 25bp, 100bp total this year (+USD)

2. Dot plot signals 2 instead of 3 rate hikes in 2019 (-USD)

3. Risks are roughly balanced, says outlook data dependent (Neutral)

4. Fed revises down 2019 GDP & Inflation forecast, inflation trends lets FOMC be patient (-USD)

5. Decision to hike was unanimous (+USD)

6. Language changes from "expects further gradual increases" to 'judges some further gradual increases' (-USD)

7. Says financial market conditions tightened, but developments have not fundamentally altered outlook (+USD)

8. Most FOMC colleagues see economy doing well in 2019, but today they see growth moderating ahead (Neutral)

9. Nothing is predetermined (pace or destination) (-USD)

10. Reached the bottom end of neutral range (-USD)

11. Policy doesn't need to be accommodative, can be neutral (-USD)

 

Next up is the Bank of England. Sterling is trading off its lows ahead of the UK central bank's final policy meeting of the year.Unlike the Fed, there will be no changes to interest rates. The last time the BoE met, they sent GBP/USD soaring above 1.30 on the talk of rate hikes. According to the summary of the report that month the MPC said "Were the economy to continue to develop broadly in line with the November Inflation Report projections, an ongoing tightening of monetary policy over the forecast period would be appropriate." To add to that Governor Carney said a Brexit deal could release pent up investment demand but a no-deal Brexit could also lead to a major supply shock that could drive up inflation and interest rates. Fast forward 7 weeks and the UK is no closer to a Brexit deal. Data isn't terrible but it hasn't been great either - while labor market activity is up and wages increased, retail sales continued to fall as manufacturing and service sector activity slowed. The FTSE is also down 4.5% since the November meeting. None of this hardens the case for BoE tightening but the big question is whether it weakens it enough for the central bank to address it. Internally, the answer is yes but publicly, we think the answer will be no for the BoE. They'll probably mention the risk of ongoing Brexit uncertainty but they may delay guidance changes to next year on the hopes that there will be more Brexit certainty in the next few weeks.

 

 

 

For more information, they can be reached at http://www.bkforex.com/.

 

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About the Author
Kathy Lien
Kathy Lien is Managing Director and Founding Partner of BKForex. Having graduated New York University’s Stern School of Business at the age of 18, Ms. Kathy Lien has more than 13 years of experience in the financial markets with a specific focus on currencies

Ms. Kathy Lien is Managing Director of FX Strategy for BK Asset Management and Co-Founder of BKForex.com. Her career started at JPMorgan Chase where she worked on the interbank FX trading desk making markets in foreign exchange and later in the cross markets proprietary trading group where she traded FX spot, options, interest rate derivatives, bonds, equities, and futures.

In 2003, Kathy joined FXCM and started DailyFX.com, a leading online foreign exchange research portal. As Chief Strategist, she managed a team of analysts dedicated to providing research and commentary on the foreign exchange market.

In 2008, Kathy joined Global Futures & Forex Ltd as Director of Currency Research where she provided research and analysis to clients and managed a global foreign exchange analysis team. As an expert on G20 currencies, Kathy is often quoted in the Wall Street Journal, Reuters, Bloomberg, Marketwatch, Associated Press, AAP, UK Telegraph, Sydney Morning Herald and other leading news publications.

She also appears regularly on CNBC’s US, Asia and Europe and on Sky Business. Kathy is an internationally published author of the bestselling book Day Trading and Swing Trading the Currency Market as well as The Little Book of Currency Trading and Millionaire Traders: How Everyday People Beat Wall Street at its Own Game all published through Wiley. Kathy’s extensive experience in developing trading strategies using cross markets analysis and her edge in predicting economic surprises serve key components of BK’s analytic techniques.


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