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US dollar slides on dovish interpretation of Fed’s neutral rate

Federal Reserve

A combination of broader resilience in the tech sector along with some decent earnings reports saw European markets finish the day higher yesterday, while US markets ripped higher led by the Nasdaq 100, after a dovish interpretation of Fed chair Jay Powell’s press conference Q&A.  

As was widely expected, the Federal Reserve raised rates by 75bps, to 2.25% to 2.5%, however the Powell press conference appeared to raise more questions than answers, which may well have been the intention, but also muddied the waters about the Fed’s ambition when it comes to combating inflation.  

While keeping the market guessing on where monetary policy is set to go next gives the central bank wriggle room if they feel the need to slow the pace of rate rises in the coming months, the ambiguity could also make its inflation fighting job harder.

By acknowledging that spending and production in the economy had softened in recent weeks, and that consumer spending had gone the same way, Powell may have been laying the groundwork for a possible slowdown in the pace of rate rises, without actually saying so outright.

Powell went on to acknowledge that the FOMC still sees inflation as way too high, and that the committee was highly attentive to inflation risks, but by saying that at current levels the Fed Funds rate is in the range of what they think is neutral, he appeared to catch the markets off guard.

This assessment of the neutral rate seems rather low based on the current projections, nonetheless his announcement that any future moves on rates would be decided on a meeting-by-meeting basis, appears to suggest that the Fed is closer to the end of its hiking cycle than the beginning.

Is that what Powell intended to convey?

With inflation already well above target, this tack on neutral seems at odds with the end of year June projections for a policy rate of 3.4% by year end, and Powell’s insistence that they want to see clear evidence that inflation is under control, which it clearly isn’t.

The market appears to have interpreted last night’s press conference as dovish, hence the sharp move higher in US markets, slide in short end yields, and a decline in the US dollar.

Whether this is the right interpretation will depend on the data in the coming days and weeks, starting today with today’s Q2 GDP numbers and weekly jobless claims data.

A lot of time was given to questions about whether the US was in a technical recession, after seeing a -1.6% contraction in Q1. We’ll find out later today with the first iteration of Q2 GDP which is expected to come in at 0.4% after a decent June durable goods number yesterday.

Weekly jobless claims have also been rising in the past few weeks, rising to 250k last week, they are expected to remain steady at 250k.

As we look ahead to today’s European open, apart from the latest US GDP numbers, markets in Europe will be looking for signs of a further slowdown in German inflation for July. In June this fell to 8.2% from 8.7% in May and is expected to fall further to 8.1%.

EUR/USD – rallied back above 1.0200 in the aftermath of the Fed decision but needs to break above the peaks last week at the 1.0275 area to kick on. While below the risk remains for a move back towards parity, and the previous lows at 0.9950. A move below 0.9950, towards 0.9660. 

GBP/USD – continues to squeeze higher, as we close in on the 50-day SMA, and down trend from the February highs at the 1.2230 area. Support remains at the 1.1870 area, with the bias remaining towards the downside while below the 50-day SMA.

EUR/GBP – has fallen below the 0.8400 area with the risk of further losses towards 0.8300. resistance remains back up near to the 0.8480 area.  

USD/JPY – drifted lower after the Fed meeting, after failing at the 138.00 area. We have support at the 135.50 area. A break of 140.00 targets the 145.00 area. Major support sits at 134.80 level and the July lows. 


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