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US Dollar Falls After Federal Reserve Raises Interest Rates - Here’s Why

federal reserve exchange rates

Treasury yields and the Dollar were both lower overnight after the Fed left markets underwhelmed. 

The greenback fell during overnight trading, helping to lift the Pound-to-Dollar rate, after markets were left disappointed by the latest Federal Reserve policy statement Wednesday night.

As was widely expected, the Fed raised its main interest rate by 25 basis points for the fifth time since the end of 2015, taking the top end of the Fed Funds range to 1.50%, but the US central bank stopped short of signalling a faster pace of rate hikes in 2018.

Taking account of the potential economic boost likely to come from President Trump’s tax reforms, increasing numbers of economists had been suggesting the Fed might add another “dot” to its chart of policymaker projections for interest rates in 2018, but it didn’t.

Two FOMC members also voted to hold rates steady and so the decision was not unanimous.

“Despite factoring in the imminent fiscal stimulus into their GDP growth projections for 2018, however, officials still anticipate only three more rate hikes next year. In contrast, we suspect that a slightly stronger rebound in inflation next year will ultimately persuade the Fed to hike rate four times in 2018,” says Paul Ashworth, chief North American economist at Capital Economics.

Interest rate derivative markets have priced-in a total of three hikes from the Federal Reserve between now and the end of 2018, while another dot could have forced markets to accommodate for a further increase, which will have been good for the Dollar.

“Given the broad expectations for the rate hike, the market has been focused on changes in the “dots” plot and anything implied by the updated economic projections. The Fed kept its 2018 and 2019 rates outlook unchanged, with an additional three hikes in 2018 and a further two in 2019,” says Marvin Loh, a senior currency strategist at BNY Mellon.

Wednesday’s decision from the Federal Reserve was the first in a series of central bank meetings, which continue Thursday with the Bank of England decision for November and the European Central Bank decision.

“Perhaps the market is selling the dollar as the Fed does not expect a stronger effect of the tax reform despite the fact that the market has moved towards the Fed in its expectation for the key rate over the last day. Or because Charles Evans and Neil Kashkari voted against the rate hike and because a pause in the rate hike cycle in March is likely,” says Antje Praefcke, an analyst at Commerzbank.

Both the Pound and Euro gained around 0.7% over the greenback, in overnight trading, before extending gains early into the London session. The Pound-to-Dollar rate was quoted 0.18% higher at 1.3432 while the Pound-to-Euro rate rose 0.28% to 1.1359.

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Core-inflation, Treasury yields and the Dollar lower Wednesday

The US Dollar was hit by a surprise November fall in the all-important measure of core-inflation Wednesday, compounding an earlier loss brought about by renewed concerns over whether the Trump administration will be able to get its tax bill through Washington.

Core-inflation, which removes volatile food and energy items from the price basket, rose by 0.1% during November and at an annual pace of 1.7% according to the Bureau of Labor Statistics report. This was down from 0.2% in October and below the 0.2% consensus forecast for the recent month.

Headline inflation rose in line with expectations, at a rate of 0.4% month on month, up from the 0.1% growth seen in October. This amounts to an annualised rate of 2.2%.

“Softer than trend readings on housing, medical care and clothing were behind that miss,” says Avery Shenfeld, chief economist at CIBC Capital Markets. “The soft core readings will be bullish for Treasuries today, negative for the US$.”

US Treasury yields fell and the Dollar gave ground to all of its G10 rivals in response to the report. The Pound-to-Dollar rate was quoted 0.28% higher at 1.3355 after the release, while the Euro-to-Dollar rate was marked 0.14% higher at 1.1757 after reversing an earlier loss.

The report comes ahead of the latest Federal Reserve monetary policy announcement due at 1900 London time, and after concerns flared again over whether the Trump administration can get its tax-bill through Washington - now that Republicans have lost a senate seat

An interest rate hike in Wednesday’s Federal Reserve policy statement is about as close to being guaranteed as one can get and, for all of the talk around weak underlying inflation pressures, Wednesday’s data may be unlikely to deter the Federal Reserve from its course toward higher rates in 2018.

After all FOMC rate setters have kept a steady hand in 2017, continuing to project an eventual return of inflation to its 2% target, despite a 40 basis point fall in consumer prices earlier in the year that left many sceptical about the merits of further rate hikes.

Above: Pound-to-Dollar rate shown at hourly intervals.

 

Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.

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