Dollar Weakens to 7-Week Low after Fed Rate Hike

The United States (US) dollar falls to a seven-week low against a basket of currencies and is likely to stay weak after the U.S. Federal Reserve raised rates by 25 basis points despite banking troubles–but also signalled rates may be close to a peak–ING analyst Francesco Pesole says in a note.

“The dollar weakened on the back of the moderate dovish surprise by the Fed yesterday, and reluctance from the Treasury to consider an extension to the deposit insurance,” Pesole says.

Sentiment towards the dollar should stay bearish especially against European currencies, albeit with small corrections high rather than a straight-line dollar depreciation, he says. The dollar index (DXY) falls to a low of 101.9150.

The well-known verse “a spoonful of sugar helps the medicine go down” might have inspired Jerome Powell yesterday as he and his FOMC colleagues offered markets a few dovish hints while delivering a potentially painful 25bp rate hike, Pesole stated.

However, ING Economic analysts doubt the dovish market reaction was either a surprise or an unwanted development for the Fed.

Many had argued that one objective of the Fed yesterday was to avert a major setback in financial market sentiment, the market reaction would suggest this was achieved, and the drop in equities might actually be mostly a function of Secretary Janet Yellen dismissing speculation that the Treasury is planning to provide “blanket” deposit insurance to banks.

However, that came at a price: a considerably less clear Fed communication.

No trade-off between price and financial stability is essentially possible only if financial conditions tighten enough to bring down inflation, or if regulators and other institutions effectively manage to restore market confidence without anything more than the financial stability tools offered by the Fed.

“This second scenario requires indeed that, as Powell stated, the US banking system is very solid. Markets are, so far, not trusting the ability of the Fed to treat inflation and financial stability independently.

“This looks unlikely to change soon, which means that rate expectations should remain strictly tied to developments in the banking crisis. And this brings us to the FX implications”, Pesole said.

The dollar weakened on the back of the moderate dovish surprise by the Fed yesterday, and reluctance from the Treasury to consider an extension to the deposit insurance.

At the same time, a new regional lender, PacWest is facing increasing turmoil on deposit outflows and First Republic’s rating was cut from BB to B by Fitch.

So, with a market not trusting the more ambiguous Fed communication and the US regional banking crisis far from resolved, it looks like investor bias on the Fed may stay on the dovish side.

This should translate into a continued bearish bias for the dollar, primarily against European currencies should the stabilisation in European sentiment continue.

Still, ING analysts said they see a high chance of seeing small USD upside corrections on the way, rather than a straight-line USD depreciation. #Dollar Weakens to 7-Week Low after Fed Rate Hike.