UPDATE
US Dollar (USD) Exchange Rate Jumps to 3-Week High after Fed Decision
The US Dollar (USD) exchange rate surged to a three-week high following the FOMC rate decision. As expected by the majority of industry experts, the Federal Reserve opted to bring its QE3 stimulus scheme to an end following a two-day policy meeting.
The Fed cited the improvements in the US labour market as the primary reason for their decision. The increase in payrolls and consistent decreases in jobless claims counteracted concerns regarding the slowing pace of domestic and global growth.
The FOMC commented; ‘Labor-market conditions improved somewhat further, with solid job gains and a lower unemployment rate. A range of labor market indicators suggests that underutilization of labor resources is gradually diminishing.’ This was a slight improvement on previous statements that labour resources ‘significantly’ underutilized.
As expected, the Federal Reserve left interest rates unchanged. In the aftermath of the decision the US Dollar (USD) exchange rate jumped to a three-week high against the Yen. The US Dollar also gained by the most for four weeks against a basket of its currency peers.
US Dollar gains were a little limited as the FOMC left its interest rate rhetoric unchanged, stating that borrowing costs would remain on hold for a ‘considerable time’.
According to industry expert Alan Ruskin; ‘The FOMC played up the strength of the labour market, and downplayed the extent to which lower inflation expectations were likely to impact long-term inflation and by extension policy. The response has been a clear-cut stronger USD.’
The US Dollar to Euro exchange rate rallied by 0.7% against the Euro and achieved a high of 0.6250 against the Pound (USD/GBP)
ORIGINAL ARTICLE, Published before FOMC Decision.
Will Janet Yellen and the Federal Reserve bring QE to an End?
Ahead of the Federal Reserve’s highly anticipated policy announcement, the US Dollar (USD) exchange rate was broadly softer as investors speculated on the course the central bank was most likely to take with regards to fiscal policy.
The Federal Open Market Committee will conclude its two day policy meeting later today and deliver a policy statement which has the potential to shake up financial markets and could inspire notable US Dollar movement.
Just a few months ago industry experts had been betting that the US economy’s second quarter rebound and the tightening in the nation’s labour market would push the Fed into becoming the first central bank of the Group of Seven nations to increase interest rates.
Now, however, global economic growth concerns and a run of patchy US data have left few people expecting borrowing costs to be raised before the second half of next year. Federal Reserve Chairwoman Janet Yellen has also been unflinchingly dovish on the subject of US fiscal policy since taking over from Ben Bernanke.
Towards the beginning of October, the International Monetary Fund negatively revised its global growth forecasts and stressed that the recovery since the onset of the economic crisis in 2008 has been ‘weak and uneven’.
Although the outlook for the US was sharply revised, recent reports have indicated that the pace of growth in the world’s largest economy has almost certainly slowed markedly in the third quarter of the year from the second.
The situation in the Eurozone is also bleak, with the currency bloc on the verge of entering a triple-dip recession.
These factors have combined to convince industry experts that the Federal Reserve will be leaving interest rates on hold for the foreseeable future.
Will US Interest Rates be on Hold for a ‘Considerable time’?
However, even with the headwinds facing the US and global economies, the Fed is still expected to bring its third round of quantitative easing (QE3) measures to an end.
The central bank introduced QE3 back in 2012 and over the past two years the scheme has resulted in the purchase of bonds worth over 1.5 trillion Dollars.
The programme, designed to improve liquidity and bolster growth, has been gradually wound down over the course of the year, with the Fed cutting the pace of purchases by increments of 10-15 billion Dollars at every FOMC policy meeting.
This month’s reduction of 15 billion Dollars would be the last. However, there are some industry experts who feel that the central bank should delay concluding QE3 for at least another month.
The odds of the FOMC opting to keep QE3 in place until its December gathering are low, but if the central bank did surprise markets in this way, the US Dollar (and higher-risk currencies like the Australian Dollar, South African Rand and Indian Rupee) would be significantly affected.
The maintenance of QE3 would undermine demand for the US Dollar, but make the aforementioned assets more attractive to investors.
Tonight investors will also be dissecting every sentence of the statement to see if they can piece together a timeline for the increase of borrowing costs from the policy makers commentary.
The key phrase to be aware of is ‘considerable time’ – which has frequently been used in reference to how long interest rates will be kept on hold for.
The term ‘significant underutilization’ (which is reflective of the level of slack in the US labour market) will also be scrutinised.
If the Fed drops these phrases, which it is unlikely to do given the current economic climate, the US Dollar could rally and recoup the losses sustained over the course of this week.
Expert Opinion on the FOMC, QE and Interest Rates
Market analyst Peter Boockvar stated; ‘Outside of the official end of the QE today, we’re back to parsing the wording of the FOMC statement. ‘Considerable time’ has been rendered worthless in telling us anything of significance as Yellen in her last press conference backed away from it and said to focus on the data. Also, three weeks ago Stanley Fischer said ‘considerable time’ can be anywhere from two months to two years. ‘Significant underutilization’ is the key to watch and whether it stays in’.
Forex strategist Kit Juckes noted; ‘Along with the majority of observers, we expect a final $15 [billion] cut in the Fed’s monthly bond purchases, and no meaningful change in the language from the FOMC statement. There will be no new dots, no new projections and no press conference. It should be a non-event, and you wouldn’t rule out another rise in equity indices around the world given the recent momentum.’
Chief economist Stephen Guilfoyle obserted; ‘The Fed is going to wait until a later time before it announces an increase in the Fed funds rate. [QE] will come to an end, finally. The Fed funds rate will stay where it is. The key thing will be the wording of the Fed’s statement. If the words ‘considerable time’ stay in their forward guidance, then I think that’s a real positive.’
US Dollar (USD) Exchange Rate Forecast
Just ahead of the Federal Open Market Committee policy announcement the US Dollar was stuck in its longest run of declines for four months, having fallen to a one-week low against a basket of its rivals and dropped against the Euro for a fourth day.
While the expectation that the Fed will adopt a dovish tone has been largely priced into the market, a change in phrasing or an insinuation that the central bank could reintroduce quantitative easing would be negative for the US Dollar and could see the currency touch fresh lows against peers like the Pound (GBP/USD) and Euro (EUR/USD).
In the view of one industry expert; ‘The end of QE is all but certain, but the question is how the Fed views the mixed economic data. If the statement retains the phrase that rates will stay low for a ‘considerable time’, the immediate reaction may be to sell the Dollar’.
However, if the Fed’s bullish contingent has its way and the language used by the central bank is positively adjusted, the US Dollar could rebound, recouping recent losses and approaching the tail end of the week on a high.
In the hours leading up to the decision the US Dollar to Euro exchange rate hit a low of 0.7845, the US Dollar to Pound Sterling exchange rate fell to 0.6189 and the US Dollar to Australian Dollar weakened to 1.1222.
We forecast that softness in the US Dollar (USD) exchange rate will persist until the FOMC delivers its decision and that further losses will be posted if the central bank either leaves its commentary unadjusted or else emphasises the fresh headwinds facing US economic growth.
Before the close of the European session the US Dollar to Pound Sterling (USD/GBP) exchange rate was trending in the region of 0.6190.
UPDATE
On Thursday the Pound Sterling to US Dollar (GBP/USD) exchange rate pared declines ahead of the publication of US GDP data for the third quarter before stabilising around the day’s opening levels.
While bets that the Federal Reserve will increase borrowing costs before the Bank of England undermined demand for the Pound later in the session, the US Dollar was buoyed by the news that the US economy grew at a faster-than-forecast pace in the third quarter of the year. The nation expanded by 3.5% instead of the 3.0% forecast.
This was down from growth of 4.6% in the second quarter. If the US economy is able to continue this momentum in the fourth quarter, the Federal Reserve might be persuaded to hike interest rates in the spring of next year.
The GBP/USD exchange rate fell to a low of 1.5950 during local trading.
