More Dollar Strength Ahead?

Anyone hoping for a pivot was sorely disappointed after last night’s Fed (FOMC) meeting. Chair Powell once again reiterated the Federal Reserve‘s commitment to bringing inflation down. His comments sent stock markets down, bond yields higher, and strengthened the dollar.

Initially, the dollar sold off as markets focused on this comment in the statement:

“Ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”

“In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

This was new. Introducing the idea that future decisions would be influenced by the cumulative (and lagging) impact of higher interest rates. Markets had seemed desperate to find any hint of a policy pivot and seized on this point. The dollar weakness sent EURUSD higher. Then it all reversed during the press conference:

The key line that triggered the reversal?

“We still have some ways to go. And incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected.”

Followed up with:

“It’s very premature to think about or talk about pausing our rate hikes”

This is not the pivot markets were looking for. US Interest rate futures are now pricing a terminal/peak interest rate of over 5% by May 2023, along with a high probability that the discount rate stays at that level for the remainder of the year.

So, the same forces that have been driving the dollar throughout most of 2022 are still present, and if the Federal Reserve is correct, likely to persist. Central banks elsewhere that had begun the process of slowing rate hikes and even looking toward a potential pause could find themselves even further behind the Federal Reserve with wider rate differentials.

That’s one thing to watch from the Bank of England decision today. Will they hike the full 0.75% that markets are pricing? If not, it would be no surprise to see the pound weaken again, especially against the dollar.

Then it’s onto the big battle: USDJPY. The dollar has a lot of fundamental factors on its side. Widening rate differentials, terms of trade and so on. However, Japan’s central bank and Ministry of Finance have intervened to prevent further yen weakness lately.

Originally, they were showing concern about the speed of change in the exchange rate, now they’re also concerned about the depreciation of the currency and concerned that a weak yen will boost living costs through higher import bills.

The Ministry of Finance disclosed that they spent over $42 billion intervening in October alone. Some interventions were stealthy, and others stood out like a sore thumb:

Even after shelling out $42 billion, USDJPY is looking stronger again, recently posting a higher low before rallying and gathering momentum in the wake of yesterday’s non-pivot by the Federal Reserve. Onto the next episode of dollar strength?