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Powell's speech supports dollar dominance, but interest rate policy may push limits

2024-04-18

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The dollar was supported by the latest warning from Federal Reserve Chairman Jerome Powell, who said interest rates will need to remain at current levels for longer than he previously expected, but that the Fed's rate policy may now be approaching its limits.

"Recent data clearly do not bolster our confidence but suggest that achieving that confidence may take longer than expected," the Fed chairman said.

Following these comments, markets are pricing in only 38 basis points of rate cuts from the Fed in 2024, further supporting U.S. bond yields and the dollar.

GBP/USD fell to a fresh low of 1.2405 following the comments, although it was followed by some stronger-than-expected UK inflation data and has now recovered to 1.2451. EUR/USD fell to 1.0600 but has now recovered to 1.0666 as the pound rebounded.

Jamie Dutta, an analyst at Vantage Markets, a provider of foreign exchange trading accounts, said: "The dollar hit a new high and rose for the fifth consecutive day. Federal Reserve Chairman Powell retracted his comments about cutting interest rates."

In comments delivered alongside Bank of Canada Governor Steve McCallum, Powell said: "If higher inflation persists, we can maintain [interest rates] at current levels for as long as needed."

Markets began 2024 expecting as many as 150 basis points of rate cuts in 2024; but this has been reduced to just 38 basis points due to repricing, which has pushed U.S. bond yields higher and attracted funds into dollars. At the same time, declines in global stock markets reflected declining investor confidence, increasing demand for safe-haven assets such as the U.S. dollar.

This creates a win-win situation for the dollar, with further gains likely to be high.

Lee Hardman, senior currency analyst at Bank of Japan-Mitsubishi UFJ, said: "The sharp rise in U.S. yields has put more pressure on risk assets. The rise in the U.S. dollar index so far is even more impressive, It's up nearly 6% since its lows late last year."

Fed Vice Chairman Philip Jefferson and Richmond Fed President Thomas Barkin also echoed Powell's remarks. Jefferson said he expects inflation to continue to be moderate at current interest rates, but that persistent price pressures will require borrowing costs to remain higher for longer.

FX market participants must now wonder how much longer this theme can develop. After all, in most cases of the Fed's expected repricing in 2024, this means diminishing marginal returns.

In short, investors need to pay close attention to whether the dollar's appreciation has reached its limit, as the Fed's repricing operation has reached a climax.

Valentin Marinov, head of G10 FX strategy at Crédit Agricole, said: “U.S. 2-year Treasury yields are only short-lived, given that the rhetoric confirms what investors are already thinking. rose above 5% and the dollar received no further support," he said, referring to the limited impact of the Fed's recent comments on the market.

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Powell's speech supports dollar dominance, but interest rate policy may push limits

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