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Dollar falls despite US rate rise; BoE next

Dollar falls despite US rate rise; BoE in focus As the market expected, Jerome Powell delivered a 25 basis point rate hike, yet rather than sending the dollar higher we saw a distinctly dovish market response. The GBP/USD rallied to its highest level in a month, USD/JPY tumbled below 106 and US equity indices ended lower across the board. So, what caused this response?

 

The dot plot

Going into the release markets had been focusing heavily on the future path of interest rate rises. 3 or 4 rates hikes this year had been dividing traders. The market received confirmation that there would be just two more hikes this year, disappointing those that had assumed more. The Fed are looking to hike more aggressively in 2019 and 2020, most likely a reflection of the impact of fiscal stimulus on the economy and monetary policy. However, this was little consolation for those who had positioned themselves for 4 hikes.

 

The inflation mystery

The inflation mystery continues to haunt the Fed. Whilst the statement indicated the Fed was comfortable that inflation would gradually move towards its 2% target as the economy strengthen, in Powell’s not so hawkish press conference he said there was no evidence to suggest that inflation was going to suddenly pick up. This was enough to send treasury yields diving, pulling the dollar lower. US indies across the board also sunk. The bearish reaction from the market suggests that future dot plots were cast aside to focus on the inflation mystery which is still engulfing the Fed.

 

Wages, wages, wages

Powell expressed his surprise at how low wages remain given the extent of tightening in the labour market and its overall strength. This was also interpreted in a dovish light.

 

Powell vs Yellen

Generally speaking there was a certain bluntness to Powell’s responses, which differentiated him from Yellen. However, the message was the same, he broadly stuck to the Yellen script, not surprising given that he was the continuity pick. Yellen’s game plan of gradualism was well and truly present at the not so hawkish press conference.

 

BOE in focus

Attention will now switch towards the BoE rate decision. . Given there is no press conference, the focus will be on vote split and the BoE statement. Whilst the central bank is not expected to raise rates today, bets are increasing that there could be a late spring/ early summer hike. Traders will be watching carefully for any hints of hawkishness which point towards a spring/ summer hike, particularly given that certain head winds have evaporated; for example, a Brexit transition deal is agreed and wages are set to overtake inflation.

 

The pound has displayed significant strength leading up the BoE announcement. Any signs the BoE is considering hiking faster than originally planned will help the pound extend those gains. A vote split other than 9-0 will start to feed these hike hopes and boost the pound.

 

GBP/USD is hovering around resistance at $1.4170. Hawkish signs from the BoE could push the pair to resistance $1.4230. On the downside watch for support at $1.41.

 

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