Why did the US dollar rally after the Fed cut rates?
The US dollar rose to a fresh two year high against the euro on Wednesday evening, despite the Federal Reserve cutting interest rates for the first time in more than a decade.
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n line with our expectations, the FOMC voted in favour of lowering rates by 25 basis points back to a range of 2.00-2.25%, defying some of the market that were looking for a more aggressive 50 basis point rate reduction. While the announcement would ordinarily be negative for the domestic currency, the US dollar rose sharply across the board as investors very much viewed last night’s rate reduction as a ‘hawkish cut’.

Firstly, the vote among FOMC members was not a unanimous one, with two members of the committee voting in favour of unchanged rates. Powell’s comments were also not as dovish as the market had anticipated. He voiced optimism over the strength of the US labour market, while also noting the recent improvement in retail sales data. Crucially, he also fell short of indicating that a full-blown easing cycle was on the way, instead claiming that the cut was merely a ‘mid-cycle adjustment’.

The aforementioned comments from Powell fell short of the lofty market expectations, which had been pricing in another two interest rate cuts from the Fed later in the year. While Powell did not state that Wednesday’s move was a ‘one and done’ scenario, he did indicate that additional cuts would be data-dependent. His suggestion that ‘nothing in the US economy poses a major near term threat’ is an indication that we would need to see a deterioration in macroeconomic news in the coming months in order to once again force the Fed’s hand.

Markets were caught wrong-footed by the announcement, with EUR/USD surging towards the 1.10 level and its lowest level since May 2017 (Figure 1). We think that additional short term gains for the dollar could be on the cards in the coming days as the market continues to lower its expectations for additional Fed rate cuts during the remainder of the year.

Figure 1: EUR/USD (31/07/19 - 01/08/19)

Source: Thomson Reuters Datastream Date: 01/08/2019

Bank of England to release quarterly Inflation Report



With this week’s Fed meeting out of the way, attention in the market now shifts to this afternoon’s Bank of England monetary policy announcement.

Not only will the BoE be announcing its latest interest rate decision, but it will also be releasing its latest quarterly Inflation Report. Policy news in the UK has very much gone under the radar amid growing Brexit uncertainty. We think that today’s announcement will be more or less the same thing. Policymakers have made it clear that the bank would await more concrete developments on Brexit before it decides on the appropriate course of action. We expect this message to be reiterated by Governor Mark Carney during his press conference just after midday.

The key to the reaction in the pound could, therefore, be the updated growth and inflation forecasts. Any meaningful revisions here could be the biggest single driver of the UK currency today.
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