US Dollar lower after Fed says it will be ‘patient’ with interest-rate increases

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January 31, 2019 12:01pm NYSE:UUP

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From William Watts: The Federal Reserve and its chairman, Jerome Powell, changed their tune Wednesday, striking a surprisingly dovish tone that sparked a stock-market rally, tanked the U.S. dollar and roiled other financial markets.

The Fed hinted that it may be at the end of its rate-hike cycle and further surprised investors by issuing a separate statement regarding its balance sheet, indicating that its efforts to reduce the $4 trillion asset portfolio could end sooner than expected. The tone was seen as an about-face from the Fed’s hawkishly received December meeting when it delivered its fourth rate increase of 2018.

“This is one of the most dovish turnarounds by a Fed chair that I have ever seen in my 30-year career,” said Tom di Galoma, managing director at Seaport Global Holdings.

And the initial reaction across markets appeared in keeping with the perceived shift.

The message delivered by the Fed “just couldn’t be much better for both bonds and equities and for the credit markets that track Treasurys,” said Mark Grant, chief global strategist at B. Riley FBR, in a note.

Equities soared, surging in the wake of the Fed’s statement and during Powell’s news conference before trimming gains, but still ending sharply higher. The S&P 500 SPX, +0.85% closed up 1.6% at 2,681.05, a nearly seven-week high. The Dow Jones Industrial Average DJIA, -0.10%  ended 434.90 points higher at 25,014.86, a gain of 1.8%.

For the S&P 500, it was the biggest one-day gain on the final day of a Fed meeting since December 2014, according to Dow Jones Market Data.

Stock-index futures pointed to a mixed start for Wall Street on Thursday.

The remarks sparked a Treasury rally that saw yields (which move in the opposite direction of price) drop, particularly at the short end, leaving the yield curve — a line plotting yields across all maturities — to steepen. Yields at the short end are more sensitive to expectations surrounding Fed policy. The yield on the two-year Treasury note TMUBMUSD02Y, -1.60%  fell 4.4 basis points to 2.524%, while the 10-year yield TMUBMUSD10Y, -1.50%  declined 1.8 basis points to 2.694%.

Treasurys extended their rally, further weighing on yields, in early Thursday action.

The U.S. dollar may have bore the brunt of the market reaction, selling off across the board after the Fed’s dovish surprise. The euro EURUSD, -0.2526%  and the Japanese yen USDJPY, -0.15%  both strengthened sharply, leaving the ICE U.S. Dollar Index DXY, +0.10% a measure of the currency against a basket of six major rivals, erasing gains to turn lower.

The dollar remained under pressure early Thursday.

Now what?

Not everyone was popping the champagne. Some economists feared the Fed had eroded its credibility, caving into market pressure.

“Talk about a Fed put,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics, in a note, referring to the idea that central bank policymakers have grown increasingly sensitive over the years to stock-market declines and stand ready to intervene in an effort to provide calm. (In real life, a put is an option that gives the caller the right, but not the obligation, to sell an asset at a set price by a certain time, a potentially valuable hedge if the underlying asset heads south).

Shepherdson, who described the Fed as “excessively” dovish, said the degree of steepening of the two- versus 30-year yield curve “suggests that not all bond investors are thrilled with the speed at which the Fed has backed away from its previous position.”

The meeting shows policymakers are “going all-in on the slowdown story, despite the incredibly tight labor market, accelerating wages and rising business price expectations,” he said, which could force policymakers to “spin on a dime” and resume tightening around midyear in order to avoid a “serious policy error” if the economy holds up.

Others played down the Fed’s rhetorical shift. Eric Winograd, senior economist at AB, described it as a completion of the Fed’s pivot from policy “normalization” to a “data-dependent” stance, which he termed “entirely appropriate” given signs the economy is slowing.

“Honestly, I don’t think things are much different after the meeting than before,” he said in a note. “The committee did not want to repeat the debacle that was the December meeting and so were thoroughly dovish. The more dovish they are today, the better the economic outlook becomes and thus the higher the probability is that they will eventually have to start raising rates again. I continue to expect that to happen, but not until the second half of the year.”

The Invesco DB US Dollar Index Bullish Fund (UUP) was trading at $25.38 per share on Thursday morning, up $0.04 (+0.16%). Year-to-date, UUP has gained 5.62%, versus a 1.37% rise in the benchmark S&P 500 index during the same period.

UUP currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 17 ETFs in the Currency ETFs category.

This article is brought to you courtesy of MarketWatch.

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