The United States dollar plunged against major currencies on Wednesday after the Federal Reserve struck a dovish tone, revising its economic projections and signaling that interest rate cuts are likely later this year to engineer a long-awaited “soft landing” for the economy.
In a move that caught many investors off guard, the central bank’s latest quarterly economic projections showed the median Fed policymaker now expects three quarter-point rate cuts in 2024, down from projecting just one cut at the December meeting. The Fed also upgraded its growth outlook for this year while trimming forecasts for unemployment.
The surprisingly dovish pivot sent the dollar tumbling, allowing a broad rally in currencies from the Japanese yen to the Australian dollar as traders rapidly priced in an easier monetary policy stance from the Fed going forward. Global stocks and bond markets also rallied on hopes the central bank can navigate a path to taming inflation without causing a severe recession.
“The market heard a very different, more dovish tone from the Fed than it was expecting,” said Kathy Jones, chief fixed income strategist at Charles Schwab. “The message was that they believe rate cuts will likely be needed this year to keep the economy out of recession.”
The moves represented a stark reversal from recent trading, which had seen the dollar index hit multi-decade highs as the Fed engaged in an aggressive rate-hiking campaign to wrestle inflation under control. But that powerful exchange rate momentum seems to have broken for now.
“The Fed has effectively given the green light for dollar weakness,” said Karl Schamotta, chief market strategist at Corpay. “By signaling that rate cuts are likely coming sooner than markets expected, the central bank has removed one of the biggest supports for the currency.”
After Powell’s comments, the ICE U.S. Dollar Index, which measures the greenback against a basket of major currencies, suffered its biggest one-day drop in over two months. It continued sliding in Asian trading before finding some support in Europe.
The dollar lost as much as 2.7% against the yen, briefly dipping below 150 yen per dollar for the first time since mid-January. It later pared losses but remained down around 1.5% on the day. Meanwhile, the Aussie dollar surged nearly 2% to a three-week high after a blowout Australian jobs report added to the currency’s Fed-inspired gains.
In equity markets, Japan’s Nikkei 225 jumped 2.3% to lead rallies across Asian bourses, boosted by the yen’s rebound against the dollar. European stocks were also firmly higher, with the regionwide Stoxx 600 index up around 0.6% in early afternoon trading and Wall Street futures pointing to a stronger open.
“Risk appetite has snapped back very quickly after the Fed delivered exactly what it wanted to – a more dovish outlook and the scope to take the foot off the rate-hiking pedal,” said Shane Busert, managing director at Solumus Financial.
Still, some analysts questioned whether the central bank’s new projections may be overly optimistic given sticky core inflation trends and a robust labor market that could require more tightening to fully rein in prices.
“While it’s good news that the Fed expects to avoid a severe recession, markets may be getting a bit ahead of themselves in pricing rate cuts so rapidly,” said Ryan Detrick, chief markets strategist at Carson Group. “We could still see inflation pressures forcing further rate increases from the Fed before any cuts actually materialize.”
In the bond market, the Fed’s projected rate cuts for 2024 brought a rapid repricing of interest rate expectations. Fed funds futures surged as traders pulled forward their bets for when the first rate cut could arrive, with many now eyeing a reduction as soon as June.
The yield on the 2-year Treasury note, highly sensitive to interest rate expectations, tumbled around 15 basis points to 4.53% as traders bet the Fed would not raise rates quite as high as previously anticipated. Longer-dated Treasury yields also declined, with the 10-year sliding below 3.5% from around 3.6% ahead of the Fed’s announcement.
The knee-jerk market moves partly retraced later in the day amid lingering uncertainty over the Fed’s precise rate path. But the overall sentiment shift shows investors have quickly repositioned for a more benign monetary policy outlook compared to the aggressive tightening previously priced in.
In commodities markets, gold prices vaulted to another record high above $2,219 an ounce as the prospect of lower interest rates diminished the opportunity cost of holding the non-yielding asset. Oil prices were mixed, with international benchmark Brent crude off around 0.6% on reduced fears of overly restrictive Fed policy dragging the economy into recession.
Still, most analysts saw the Fed’s actions as setting the stage for potential dollar weakness in the period ahead as the central bank moves closer to cutting interest rates.
“With the market now pricing in rate cuts, yields should begin moving lower and the dollar is likely to follow,” said Bipan Rai, head of FX strategy at CIBC Capital Markets. “The Fed’s dovish pivot is capable of fueling a sustained, broad sell-off in the greenback from here.”
Whether a prolonged dollar downturn materializes could hinge on upcoming inflation data, the pace of further Fed policy shifts, and evolving growth dynamics in key economies overseas. But for now, Chair Powell has given the foreign exchange market a green light to abandon one of 2022’s biggest trends – the blistering rise of the U.S. currency.
