US Federal Reserve just keeps on underpinning the dollar

The US Federal Reserve delivered the rate hike very much as expected on Wednesday (26 September), and there was also very little change to their expectations for the future, with the median rate projections for 2018,2019, and 2020 all unchanged from their June projection at 2.4% 3.1% and 3.4% respectively.

The one very slight change was an upward revision to the median longer run rate projection to 3% from 2.875%, but this only returned it to the 2017 level. As expected, the statement removed the reference to policy being accommodative, but Fed chair Powell said in the press conference that policy was still accommodative, and while endorsing the idea of a continuation of steady hikes as being the most likely path, also indicated the possibility of a rate cut if the economy weakened and inflation fell.

There was little net impact on the USD, with an immediate USD decline on the news being quickly reversed. Long US bond yields fell slightly from the four month high registered on Tuesday. An initial slightly positive equity market response was more than reversed by the end of trading.

All in all this was really quite a newsless Fed rate hike. Steady as she goes was the message. Another rate hike is expected in December and three more next year. But as long as the pace of rate hikes continues in line with expectations and the perceived “neutral rate” remains near 3% there is unlikely to be much impact on US 10 year yields from Fed policy and consequently little impact on the USD.

The USD has been boosted in the last few years by the rise in US yields and the widening yield differential with the rest of the world where the rate hiking cycle has either not started or is in its infancy. But spreads have now been broadly steady since May, and the focus may now be more on policy elsewhere in terms of triggering a reversal in spread widening. Even though the ECB is not expected to raise rates until the second half of 2019, any potential ECB tightening is now a much more significant issue for spreads and EUR/USD than the Fed.

However, for the moment central banks are not the primary concern in the markets. For EUR/USD today the focus is more on the Italian budget announcement, with potential political conflict both internally and with the EU, and the EUR has fallen on reports of the Italian budget meeting and announcement being delayed.

For GBP/USD, the primary focus is still on Brexit negotiations, with the failure of the Salzburg Summit to find any deal bringing the focus more keenly on the UK Conservative Party Conference next week. For the USD in general, the fluctuations in the trade disputes with China, Canada and others continue to have an impact, though the impact of each tit-for-tat tariff announcement does seem to be diminishing. 

Nevertheless, the Fed has underpinned US yields and the USD with this announcement of a rate hike and the expectation of more to come. While it was essentially expected and will not create more USD strength in itself, it will require positive news from elsewhere to start to reverse the USD rise seen in recent years.

For now, political uncertainties in Europe make it hard to see sustained strength in the EUR or GBP. Brexit negotiations look unlikely to produce an agreement until November at the earliest, and a failure to agree is looking increasingly likely. Eurozone politics is probably less immediately dangerous, but situations like Italy remain a background concern holding the EUR back. The 1.18 area in EUR/USD and the 1.32 area in GBP/USD consequently look like strong short term resistances with the downside favoured for now.

Sell 1 month EUR call/USD put strike 1.18. Sell 1 month GBP call/USD put strike 1.32