USD dips As Fed Seems Open To Further Hikes

The Federal Reserve has raised rates by 50 bps as expected and seems open to further hikes. QT program launch and its potential ramp-up make the dollar scarcer.

What most market participants see as most important, is the Fed comment on inflation: it is still high, “owing to supply and demand mismatches caused by the pandemic, rising energy prices, and broader price pressures”. The latter is the most critical point – inflation is broad-based.

Lack of hints about peak inflation adds to a continues state of uncertainty, another positive merit for the USD. The Fed seems to be declaring war on inflation, leaving investors in the dark about how high-interest rates will rise. That is dollar positive, and so is the Fed’s flexibility on withdrawing dollars from markets.

The dollar is initially lower, due to several factors. First, a “buy the rumor, sell the fact” response. Second, the Fed refrained from promising an “expeditious” cycle, and without a promise to act fast, the algorithms seemed to have sold off the dollar. Third, the decision has been unanimous, hawk James Bullard refrained from voting for even more aggressive policy.

The Fed states that household spending and business fixed investment remained strong in the first quarter, despite an editing down in economic activity. On one of its mandates, employment, it stresses that “job growth has been strong in recent months.”

The world’s most powerful central bank raised interest rates by 50 bps to a range of 0.75% to 1%, as fully expected. The officials at the Washington-based institution also launched a Quantitative Tightening (QT) program, in which it lets bonds mature without reinvesting the proceeds, thus shrinking its balance sheet.

While these two steps were fully priced in, the path of the next rate hikes and the final interest rates remains uncertain. If there is one thing markets hate is uncertainty. But for traders, this is a boon. “Make the trend your friend” remains the name of the game.

The dollar benefits not only from higher US rates but also from uncertainty, as the USD attracts safe-haven flows. Before the decision, talking heads on financial media discussed a final rate of 3% to 3.50%, but the bank’s statement leaves no clue as to how high borrowing costs could go. Some certainty could come in June when the bank publishes new forecasts – but these are prone to abrupt changes.

Traders have to react with certainty despite an uncertain picture, and they try to scrutinize the Fed’s statement for direction. It seems like a war on inflation, a massive change from the days of describing rising prices as transitory.

Despite the relatively moderate Core CPI figure for March – 0.3% MoM – there is no mention of price rises slowing down. Fog is hiding the peak of inflation, and that makes the upward climb harder for the Fed and for markets.

The US central bank fought the previous war of deflation back in 2021, and it might be too aggressive now. Nevertheless, Fed Chair Jerome Powell’s words matter more than one figure, which could be a one-off.

Another factor to consider for the dollar is the number of dollars in circulation. It is not only about to fall via the current QT scheme but could further squeeze. Fewer dollars, and particularly the specter of even fewer ones, mean a stronger currency.