I had felt for a while that the market had gone too far. The expectations had gone wild after the Non-farm Payrolls data a couple of weeks ago, however I remained sceptical of a June rate hike by the Fed (which according to Janet Yellen still cannot be entirely ruled out). It turns out that my caution was not without justification yesterday as the Fed cut a dovish figure and the dollar corrected sharply. Volatility has gone through the roof, but once this volatility subsides I still expect to play the strong dollar trade. I still see the dollar rally has more to run.
As expected, the word “patient” was removed from the FOMC statement and we now have:
“The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.”
Bearing in mind this paragraph, the Fed struck a dovish tone with its projections as it cut its targets for growth and PCE inflation (although it did also reduce unemployment projections):
In her press conference also, Yellen made consistent references to the low level of inflation and also the strength of the dollar. She seemed intent on putting across a definite message. The market had got overexcited and needed to be reined in.
In the week running up to the FOMC decision, the Fed Fund futures had been pricing in the potential for a rate hike as probable (c.64% chance of a rate hike) by the September meeting and possibly even in the meeting at the end of July. These expectations have been pushed back following the meeting, with September now standing at 56% and October standing at 75% (down from the previous 82%).
However, with Mark Carney pushing back on the Bank of England’s interest rate hiking expectations with his recent rhetoric, it now seems that the Federal Reserve could now be the only major central bank that sees a rate hike as a possibility in 2015. This will drive dollar strength in the medium/longer term this year.
We have seen some significant volatility in the forex markets following the decision yesterday. EUR/USD saw an intraday range of over 400 pips, whilst GBP/USD had a range of over 500 pips. Incredible moves, even in the light of the elevated volatility of the past few months.
As can be seen in the chart of Dollar Index (DXY) above, the volatile move is being unwound today. This may not be the end of the volatility though as moves on the individual forex majors remain choppy and are yet to settle down. However, you can see that once again the dollar has formed support around its rising 21 day moving average which has been a good gauge during the bull run. It would also. The RSI is currently around 64 on DXY, but the corrections tend to unwind the RSI towards 50 before the bull trend resume. This would suggest that perhaps there is more room within the uptrend for momentum to unwind. However, this chart shows that there has been little damage done to the outlook of the dollar from yesterday’s FOMC decision.
I expect that the Dollar Index will get over this near term blip and continue to push higher higher in due course as I see this bull run as having further to go yet.