The US dollar fell against the Euro after the Fed held the main interest rate unchanged at 2%, ending a series of 7 consecutive cuts. What happened? Most market participants had expected the Fed to keep the rate unchanged anyway in Wednesday’s FOMC meeting. Initially the dollar traded higher, but that subsided and traders began taking their profits on long dollar positions.
In the accompanying statement, the Fed said, “Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased.” They also said that “uncertainty about the inflation outlook remains high,” given the “continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations.” All except Dallas Fed’s Fisher voted for no change. Fisher preferred an increase in the rate at this meeting.
The Fed is very unlikely to embark on a rate tightening cycle so soon after cutting rates so aggressively as the economy still looks so fragile. An August rate hike has been thrown out the window by many traders last week, but people are already betting on a September rate raise. On the other hand, the ECB is widely expected to hike rates next week to fight the threat of high inflation, and that expectation should keep the Euro on the offensive.
EUR/USD rose to 12-day high of 1.5687, and the Euro rallied to an all-time high around 169.20 against the Japanese yen. EUR/USD’s topside targets are 1.5700-10, 1.5740. EUR/JPY has more potential to rise further as it is more lucrative for traders to seek yield when buying EUR/JPY since interest rates in Japan don’t seem to be going anywhere.
The dollar could be under pressure in the meantime, at least till the ECB rate decision next week, but from a medium-term perspective, more hawkish rhetoric from the Fed could stem the dollar’s decline. The Fed is walking a tightrope right now: If they hike rates, that could be worse for an economy that’s on the brink of a recession. If they cut rates, they risk a weaker dollar and possibly higher oil prices.
ECB chief Trichet told European Parliament on Wednesday: “I didn’t say we would envisage a series of increases. I said we could decide to move our rates by a small amount in our next meeting in order to secure the solid anchoring of price expectations.”
Economic Calendar for Thursday:
Fed vice-chairman Kohn speaks at ECB conference 1130 GMT
US GDP, core PCE, personal consumption 1230 GMT
US existing home sales 1400 GMT
NZ trade balance, GDP 2245 GMT
Japan national CPI 2330 GMT
Japan retail sales 2350 GMT