Dollar Tanks: No Rate Hikes Anytime Soon

Daily FX Market Roundup Jan. 30, 2019

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

The US dollar sold off aggressively Wednesday after the Federal Reserve made it very clear that it has no plans to raise interest rates anytime soon. The Fed has been talking about patience for weeks but made it official by removing the reference to further gradual rate increases from its monetary policy statement. EUR/USD soared to 1.15 as USD/JPY broke below 109 in response. Further weakness is likely over the next 24 hours as Asia and Europe absorbs the news. This is a big shift for a central bank that just raised interest rates in December. According to the FOMC statement, members said that in light of global economic and financial developments and muted inflation pressures, they would be patient as they determine what future adjustments to interest rates will be appropriate. They also removed the balance-of-risk assessment from the statement. In his press conference, Fed Chair Powell said the economy is in a good place but admitted that the case for raising interest rates has receded. He also indicated that further balance-sheet adjustments would probably come after rate changes because they don’t want to cause market turbulence. At the end of the day, the market had not been looking for a hike this year and that view was validated by Powell’s guidance. When the next set of dot plots is released, we may even see a downgraded forecast that more accurately reflects the market’s expectations for no rate hikes this year.

Meanwhile, trade talks aren’t going anywhere. President Trump is under pressure to make a deal but with the Huawei charges, it is not clear how serious he really is. US and China plan to hold one to two more rounds of talks before the March 1 deadline.

At the same time, the Canadian and Australian dollars were the best-performing currencies. Oil prices hit a 2-month high after the US imposed sanctions on Venezuela’s oil industry. Crude oil inventories also rose less than expected and gas stockpiles declined. We’ve seen a near-term bottom in oil but if US-China trade talks break down, we could see renewed declines in the price of crude. USD/CAD dropped below 1.32 and came within 8 pips of its 2019 low. November GDP numbers are scheduled for release Thursday and the decline in growth that we are looking for could halt CAD’s rally. The Australian dollar soared on the back of better-than-expected inflation data. Although consumer price growth slowed year-over-year, the decline was less than expected thanks to a 0.5% increase in quarterly growth. The Reserve Bank said the next move in rates will be higher and this latest report supports its positive bias.

It was no surprise to see confidence in the Eurozone fall as markets declined and growth weakened. German Consumer prices also dropped -0.8%, which took the year-over-year rate down to 1.4%, its weakest level since February of last year. It’s hard to find reasons for the euro’s strength outside of US dollar weakness. Technically, EUR/USD‘s break above 1.1450 opens the door to a stronger rally toward 1.1550 but Thursday’s German labor-market and Eurozone Q4 GDP numbers won’t help the currency. According to the PMIs, employment growth eased to its slowest level since December 2016 and growth has been weak.

Sterling also traded higher on the back of US dollar weakness but it lagged behind many of the other major currencies as the clock resets for Theresa May. With less than 60 days before the UK exits the European Union, May has 2 weeks to come up with a better alternative for the Irish backstop. She promised Parliament the opportunity to take control of Brexit on February 13 if she fails to make meaningful progress on a revised agreement. MPs want May to reopen discussions with the European Union and change the terms of the Irish border backstop. Unfortunately, the EU, Ireland and several other countries have openly rejected the proposal to renegotiate – she’s in contact with Brussels with the hope of changing its mind but if that fails, her only option is to get Parliament to support a gently revised version of the current withdrawal agreement. Either way, the next 2 weeks will be rocky for the pound and we think the risk is to the downside for the currency, particularly against the crosses.

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