Our caution paid off.
The USD sank after the FOMC meeting did not turn out hawkish enough to deliver a Fed hike yesterday or to affirm one in September. The DXY Index depreciated 0.5% to 100.89 overnight, with gains across its basket of currencies. EUR, GBP, and CHF rose 0.7% each, followed by 0.4% in the CAD and SEK. Even the JPY rose 0.3%.
By scrapping forward guidance and holding rates flat, Fed Chairman Kevin Warsh marched the Fed into a monetary “hall of mirrors” with volatile results. Instead of being relieved that the Fed kept interest rates unchanged at 3.50-3.75%, the Dow, S&P 500, and Nasdaq Composite fell by 2.2%, 1.5%, and 1.7%, respectively. The same pressure from a bearish steepening in the US Treasury yield curve also weighed on the USD. Warsh’s attempt to justify inaction by arguing that higher bond yields had already done the heavy lifting of tightening financial conditions ignored the fact that the market drove up the yield in anticipation of the Fed doing its job and raising rates yesterday.
Markets had calculated July as offering a palatable window for the Fed to hike before the November midterms. It did not help that President Donald Trump called his Fed pick brilliant, claiming that Warsh wanted to lower rates but could not because of the Fed’s “political” board, likely referring to the three FOMC members who voted for a hike. Trump also reiterated that the US should have the lowest interest rate in the world before the FOMC, adding that monetary policy should support higher growth, instead of restraining the US economy.
Hence, this stark divergence in central bank communication threatens to keep the greenback under sustained downward pressure. While Warsh leaves US markets stumbling in the dark, the European Central Bank was more unified in flagging a September rate hike, handing the EUR a distinct comparative advantage. GBP stands to appreciate if the Bank of England defies the widespread consensus of a hold and surprises with a rate hike later today. Even the Bank of Japan now has a golden window to prop up the embattled JPY by offering firmer forward guidance on its own path to higher interest rates.
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