Powell Says Rate Cuts are a Long Way Off

Above: Powell's address at the Welcome Centre in Washington.

Dollar exchange rates were underpinned by fresh warnings from Jerome Powell that interest rates will need to stay at current levels for longer than he previously expected, but the Fed repricing story might now be reaching its limits.

The Federal Reserve Chair rate cuts are contingent on gaining "greater confidence" that inflation is moving towards the central bank's 2% goal. "The recent data have clearly not given us greater confidence and instead indicate that it is likely to take longer than expected to achieve that confidence."

Expectations for the quantum of rate cuts to come in 2024 fell to just 38 basis points (one 25bp cut) following the comments, further supporting U.S. bond yields and the Dollar.

The Pound to Dollar exchange rate fell to fresh lows at 1.2405 following the comments, although it has recovered to 1.2474 following some stronger-than-expected UK inflation data. The Euro to Dollar exchange rate dipped to 1.0600, but has also recovered somewhat in tandem with the Pound to 1.0640 at the time of writing.

"USD made fresh cycle highs, up for a fifth consecutive day," says Jamie Dutta, an analyst at forex trading account provider Vantage Markets. "Fed Chair Powell walked back comments around rate cuts."

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In his comments, made alongside the Bank of Canada's chief Tiff Macklem, Powell said, "if higher inflation does persist, we can maintain the current level of [interest rates] for as long as needed."

The market walked into 2024 anticipating up to 150bps worth of rate cuts in 2024; this has been throttled down to just 38 in a repricing that has boosted U.S. bond yields and attracted foreign exchange flows into the Dollar. A fall in global equity markets has meanwhile reflected fading investor confidence, which boosts demand for safe-haven assets, such as the Dollar.

This creates a win-win setup for the U.S. currency, and further advances are likely.

"The sharp ongoing rise in US yields is beginning to weigh more heavily on risk assets," says Lee Hardman, Senior Currency Analyst at MUFG Bank Ltd. "The dollar index's gains are even more impressive year to date, having increased by almost 6% from the low at the end of last year."

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Federal Reserve Vice Chair Philip Jefferson and Richmond Fed President Thomas Barkin also echoed Powell's remarks. Jefferson said he expects inflation will continue to moderate with interest rates at their current level but persistent price pressures would warrant holding borrowing costs high for longer.

Foreign exchange market participants must now wonder how much further this theme can run. After all, the lion's share of the repricing in 2024 Fed expectations is truly in the rear-view mirror, suggesting a law of diminishing returns.

In short, we will now be watching for signs that the Dollar rally is reaching its limits as the Fed repricing move reaches its high tide mark.

"Given that this rhetoric was confirming what investors were already thinking, UST 2Y yields punched only briefly above 5% and the USD gained little further support," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole, referencing the limited market impact to the recent Fed commentary.