Fed Recap Dollar sinks despite higher Fed forecasts

The Federal Reserve, helmed for the first time by new Fed Chair Jerome Powell, concluded its two-day FOMC meeting on Wednesday, announcing a widely expected 25-basis-point interest rate hike to push the federal funds rate up to 1.50-1.75%. The FOMC statement, economic projections, and subsequent press conference highlighted significantly more optimistic outlooks for GDP and employment, but very little in the way of increases to inflation forecasts in 2018 and beyond. In recent weeks, fears that higher inflation would lead to a more aggressively hawkish Fed have weighed heavily on equity markets.

As for the highly anticipated dot plot detailing Fed officials’ latest projections for future interest rates, the median forecast for 2018 remained at three rate hikes (inclusive of Wednesday’s hike). However, the 2019 median rose from 2.5 to 3, and the 2020 median rose from 1.5 to 2. Overall, these slightly higher rate projections coupled with the optimistic statement and press conference struck a modestly hawkish tone, but not nearly as hawkish as might have been expected if the 2018 median had risen to four. Also, the Fed’s softer-than-expected outlook on inflation pressures detracted significantly from what could have been a much more hawkish statement.

In the immediate aftermath of the FOMC release and into the subsequent press conference, markets whipsawed rather dramatically as investors struggled to interpret the ramifications of the Fed’s stance. US 10-year Treasury yields initially dropped, then surged well above 2.9%, but then fell steadily back below 2.9% during and after Powell’s press conference. In contrast, US stocks initially were boosted sharply on the statement release, but subsequently fell back, ultimately to close the day moderately negative after having spent much of Wednesday in positive territory.

Perhaps the most notable market reactions to the FOMC event were the sharp tumble for the US dollar along with the strong surge for gold, both of which largely avoided the whipsaw experienced in other markets. The US dollar index began selling off strongly just after the FOMC statement release, while gold prices responded to the weakened dollar with an exceptionally robust rally. Both the dollar and gold continued their initial directional moves into and after the subsequent press conference on Wednesday.

The US dollar index once again slid below the key 90.00 psychological level and its 50-day moving average, while gold popped above $1330. The gold rally can largely be attributed to the sharp drop in the dollar, even despite the specter of higher interest rates from the Fed. As for the dollar itself, the Fed’s raised outlooks for GDP, employment, and interest rates were not hawkish enough to prompt a continued rebound for the greenback, as other factors such as persistently bearish sentiment and ongoing concerns over a global trade war continue to weigh. Whereas a median dot plot forecast of four hikes in 2018 would very likely have boosted the dollar on Wednesday, the fact that the median remained at three hikes, coupled with the Fed’s rather tepid inflation projections, provided the conditions for further dollar pressure.

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