Flimsy
Overnight there has been a significant repricing in the US Dollar. Major Dollar crosses are exhibiting significant Dollar weakness as a result of the market’s interpretation of the Federal Reserve’s decision yesterday evening. Most of the headlines from the FOMC decision would leave you scratching your head to reconcile the meeting with the overnight move in EURUSD. So here they are:
1) Unemployment forecasts are revised lower for 2024
2) Long run interest rate expectations move higher
3) Growth forecasts revised higher
4) QT to conclude ‘fairly soon’
Alongside the above takeaways, the target Fed funds rate was of course held as expected within the 5.25%-5.5% range. The committee also maintained the language regarding the timing of its expected loosening cycle as ‘at some point this year’. So how does EURUSD retrace recent price movements to gain almost one cent overnight?
The answer likely lies in a combination of two elements. As a spoiler alert, I believe these two elements have been significantly overpriced looking at today’s Dollar crosses. To allow treasuries and equities to rally at the expense of the dollar, the market focussed firstly upon the FOMC’s dismissal of the labour as an inhibitor to begin cutting rates. An economy with a strong labour market can endure higher interest rates and there are few other economies or indeed points in the US’s own history where we’ve seen such a low unemployment rate. Confirming that a strong labour market would not delay rate cuts allowed markets to price in near term cuts marginally more aggressively.
Secondly and seemingly just as fragile as a justification for a one cent move in USD, the dot plot confirmed the most likely path for adjustment in the view of the FOMC was for three 25 basis point interest rate cuts this year. There was some marginal expectation that the Fed may shift to two cuts. As this option of fewer cuts hadn’t been fully priced into the market as of yesterday and was a marginal theory at best, it also seems significantly overplayed as a justification for a one cent fall in the Dollar. The only conclusion is that the market’s frenzy to sell Dollars overnight may be short lived when it wakes up to the reality that the monetary backdrop for 2024/5 looks remarkably similar to how it did yesterday.
Discussion and Analysis by Charles Porter
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