US DOLLAR, FEDERAL RESERVE, FOMC, POWELL – Talking Points:
- US Dollar sharply lower after the Fed signals pause in rate cut cycle
- Stocks up, sentiment buoyed despite less scope for near-term easing
- Bond yield drop suggests FOMC is revisiting dovish pre-commitment
Where will markets end 2019? See our Q4 forecasts for currencies, commodities and stock indexes!
The US Dollar seesawed as the Federal Reserve shifted into wait-and-see mode having issued its third rate cut of 2019 on October 30. The policy statement conspicuously dropped the pledge to “act as appropriate to sustain the expansion” – a nod to pausing the rate cut cycle. Fed Chair Jerome Powell then changed the phrase in the post-meeting presser, saying current policy setting is “likely to remain appropriate”.
The Greenback acknowledged the rate cut pause with a modest rise, then plunged. The move lower was accompanied by a rally in the bellwether S&P 500 stock index, implying an improvement in underlying risk appetite across financial markets. At first blush, that seems to mark a notable departure from recent dynamics, where prospects for more stimulus produced risk-on results while hesitation soured sentiment.
Chart created with TradingView
DID FINANCIAL MARKETS BELIEVE FED CHAIR JEROME POWELL?
A possible explanation might be that the markets were genuinely heartened by Mr Powell’s cautiously optimistic read on the US economy. He said risks to the outlook have moved in a positive direction since officials’ last meeting, citing a strong household sector, an improvement in trade policy developments and a “materially” lower chance of a no-deal Brexit.
That would be consistent with the recent changes in the 2020 rate cut outlook. Expectations priced into Fed Funds futures reveal that markets have been downgrading scope for easing since late August. Traders now expect just one rate cut next year versus the two projected just two months ago. USD fell against the backdrop of this shift, which might reflect ebbing haven demand courtesy of an improving landscape.
Chart created with TradingView
FED APPEARS TO PRECOMMIT NOT TO RAISE INTEREST RATES
However, that seems inconsistent with the other bit of the post-FOMC market reaction: a drop in Treasury bond yields. If Mr Powell was truly able to generate some cheer, they would have probably tracked stocks higher. That they moved in the opposite direction might instead suggest that markets now perceive the Fed as having adopted a rigidly anti-tightening bias.
Chair Powell offered some clues in this regard. He said officials “don’t see inflation moving up right now,” adding that it “seems to be settling in below [the Fed’s target at] 2 percent.” He then pointedly added that the policy-setting committee “is not thinking about raising rates right now.” That signals that the central bank’s reaction function has been altered such that it will pointedly avoid tightening.
This kind of tacit pre-commitment might channel the frustration of a central bank struggling with building internal consensus – the recent rate cut cycle has been marked by vocal dissent from some FOMC members – as well as its apparent inability to actually deliver looser credit conditions. Perhaps Mr Powell and like-minded policymakers hoped to talk rates down by creating dovish certainty. That seemed to work…for now.
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— Written by Ilya Spivak, Currency Strategist for DailyFX.com
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