Unchanged Fed gives the Dollar a breather

Two more hikes this year…..at least

The Open Market Committee of the Federal Reserve at its two-day meeting which concluded yesterday left short term interest rates unchanged, but the wording of the statement provided by Chairman Jerome Powell left traders in no doubt that rates are on course to be hiked twice more this year although the comment on the inflation outlook was a little confusing.

Powell commented that the Fed’s view was that FOMC had a “symmetric” 2% target for inflation. This was taken to mean that they are looking at the moving average of CPI over the medium term. If correct, this would mean that inflation could rise above 2% without them needing to change their stance on gradual rate rises.

The June hike now looks a given unless there is a downside shock from tomorrows employment report which is not beyond the realms of possibility.

The dollar index paused in its recent rally following the FOMC statement. It reached a high of 92.84 but has corrected a little overnight making a low of 92.49 (6.30am BST). With continued positivity towards the dollar as risk appetite rises, the only cloud on the horizon is the twin deficits but in what has become Central Bank policy globally, that issue has been “kicked down the road” for now.

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Too far, too fast?

Since it made a high of 1.4377 on April 17th, Sterling has lost almost 5.75%. This is going to raise concerns about the possibility of a rate hike as inflation is now unlikely to fall further without further action. A hike in June is still not “on the cards” and the performance of the pound in the next few months will determine the course taken by the MPC.

The major issue facing the UK remains Brexit with the Government still struggling to create a meaningful yet acceptable proposal that can be presented to Brussels.

The Prime Minister is “between a rock and a hard place” over the Irish border issue damned if she accepts Brussels proposals and damned if she doesn’t.

The Cabinet is now split over the more general issue of customs union with the remain supporting members favouring a “fudge” where the UK remains a member of the EU in all but name and the “Brexiteers” claiming that is not what was voted for in the referendum. It seems that David Cameron is going to rival Tony Blair for the trophy of most infamous Prime Minister of modern times.

The pound continues to be under pressure but just as the market was extremely stretched a few weeks ago a similar situation is happening, albeit at the other end of the range, and it is questionable how much further it can fall without some form of correction.

Eurozone inflation to set tone

The only risk from today’s release of Eurozone-wide inflation data is that it could be stronger than the market expects. The expectation is for it to have returned to 1.3% month on month contributing to a year on year figure of 1.2%. This will have no bearing on the ECB’s view on interest rates and will therefore be ignored by the market.

The single currency breached the psychologically significant 1.2000 level yesterday reaching a low of 1.1938 but has rallied a little overnight following the slight dollar correction. It remains below 1.2000 and market sentiment is now demanding a test of significant support at 1.1880.

It is a case of which of the euro or Sterling falls further faster to determine the cross rate. Yesterday the pound fell making a fresh short-term low of 1.1324 closing close to this level at 1.1357.

The outlook for the euro remains reactive. With the economy performing adequately and monetary policy seemingly set in stone it will most probably simply be driven by the market’s view on the dollar becoming a proxy for the entire dollar index.