Instant Insight: Dollar Sells Off as Fed Halts Tightening Cycle
For the first time in 2 years, the Federal Reserve has decided to leave interest rates unchanged at 5.25 percent. Putting growth ahead of inflation, the Fed is taking the right step to prevent against a collapse in the housing market
The central bank is clearly concerned about the economy as the statement recognizes that economic growth has been
slowing. The Fed is also fearing that the lagged impact of their rate hikes and higher energy prices will continue to restrain consumer
spending. Trading in the US dollar has been very volatile following the rate
decision. The US dollar sold off when the Fed announced their decision to pause but the greenback quickly recuperated its gains as the traders assessed the rest of the Fed’s message and realized that the central bank left themselves the flexibility to restart their monetary tightening if
needed. The statement included a line that said “additional firming” may be needed if the economy heats up again or oil prices rise too excessively and inflation gets out of hand. However unless we have a serious shock, this is unlikely since the Fed made zero mention of the rise in unit labor
costs. In the meantime, dollar weakness could remain limited in the context of firm oil prices. The EUR/USD also failed to break above 1.29 as Lacker, the one dissenting member voted in favor of an interest rate
hike.
In the long term, this is a significant shift in the Fed’s monetary
policy. For all intensive purposes, they are done raising interest rates. Only if the economy picks up significantly or oil prices break above $80 a barrel will Bernanke risk his credibility and change his mind once again by lifting interest rates. So overall, the outlook for the US dollar is still bearish.