Fed Keeps Rates Unchanged But Dollar Rallies

The Federal Reserve kept its benchmark interest rate unchanged at 0.25%-0%, a record low. In recent weeks, the poisonous combination of quantitative easing with expectations for a record budget-deficit has been damaging the safe-haven status of the US dollar. However, judging by the sharp rally in the US dollar, the FOMC statement was more bullish than had been anticipated.

Official Statement from the Federal Open Market Committee
(With highlights from DailyFX)

Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Forecast for US dollar

Several months of quantitative easing combined with expectations of a record budget-deficit have been pushing the US dollar exchange further down against other major currencies. For instance, the EUR/USD rallied nearly 1800 pips over the last 4 months, trading from a low of 1.2544 in March to as high as 1.4337 in June. Moreover, with carry-trade still unwinding the USD/JPY fell more than 500 pips over the last 30 days. Indeed, because the United States runs both a current-account and a budget-deficit, there is no better way to express concern about the long term implications of conducting quantitative easing than by selling dollars. Having said that, in the short-term we think the US dollar will remain under heavy selling pressure until we have a clear exit strategy for quantitative easing by the US Federal Reserve. However, a recent change in 2-year interest rate differentials in favor of rate hikes by the Federal Reserve is likely to support the US dollar in the long-term.

Interest Rate Heatmap

source: TradingEconomics.com

Antonio Sousa is a Chief Strategist for DailyFX.com at FXCM in New York City where he performs global economics research and develops systematic trading strategies. Please send your comments to <[email protected]>.