For Dollar bulls Fed fails to deliver

DailyFX--The Federal Reserve cut interest rates by 25bp to 2 percent, which was right in line with the market’s expectations. However the US dollar sold off because the market was disappointed that the central bank did not give them more. This appears to be a classic buy the rumor sell the news type of reaction in the greenback since the statement was undoubtedly more hawkish than the one released in March.

We noticed 3 major changes in the statement; First, two members voted to keep interest rates unchanged. Although Plosser and Fisher dissented last month as well by favoring a smaller rate cut than the 75bp of easing delivered on March 18th, they could soon convince some of their peers to follow suit.

Secondly, the Fed took out their promise to act in a “timely manner” and instead, they simply said that they will act as needed. The statement about the downside risks to growth is also gone and even though we do not believe that the downside risks to growth have really disappeared, taking these words out of the statement is symbolic.

Finally, the Fed reminded the markets that they have eased interest rates substantially (325bp since August) and over time, their efforts should have an impact on the US economy. For all intents and purposes, the Federal Reserve is telling the markets that the economy needs time to absorb their rate cuts and their toned down statement suggests that they will not be cutting interest rates again in June. The futures market is currently pricing in a 78 percent chance that interest rates will remain unchanged at the next Fed meeting and a 73 percent chance that interest rates will also remain at 2 percent in August.

Yet the US dollar sold off because the market is not confident in the Fed’s judgment. So far, the central bank’s rate cuts have only had a limited impact on the US economy. It takes time before the monetary stimulus can be felt, but if it does not come through soon, an accelerated deterioration in the US economy could force the Federal Reserve to pick up where they left off. The FOMC statements have become longer and longer in recent months and the central bank’s increasing need to explain themselves can be worrisome for dollar bulls.