Fed Flexibility and Powell Patience Calms Market Angst

Talking Points:

  • Fed Chairman Powell takes the limelight after December’s FOMC minutes were released yesterday
  • The USD selloff is taking a break and recovering after no new dovish Fedspeak
  • The Federal Reserve leader reiterates patience and flexibility over normalizaton

The US Dollar is gaining ground as markets turned their attention to Fed Chairman Jay Powell speaking at the Economic Club of Washington earlier today. While the Federal Reserve’s leader reiterated comments previously made last Friday regarding the pace at which the central bank normalizes monetary policy, no further dovish developments provided USD bulls a chance to catch their breath.

DXY INDEX PRICE CHART: 1-MINUTE TIMEFRAME (JANUARY 10, 2019 INTRADAY) (CHART 1)

Since the Fed’s last meeting in December when the Federal Open Markets Committee raised the benchmark interest rate for the fourth in 2018, the greenback sold off as hawkish bets were thwarted by the new lower trajectory of rates for 2019. The Fed decreased its projection from 3 rate hikes to only 2 this year in response to tightening financial conditions and fading economic strength.

The lower path of interest rates indicated by the Fed compares to the futures market which is implying only a 1.4 percent likelihood of that happening with the probability of a rate cut by the December 2019 meeting resting at a sizeable 12.5 percent. As markets anticipate lower interest rates in a domestic economy, the country’s currency becomes relatively less attractive causing it to sell off. This is what has been happening to the US Dollar now that the Fed is shifting from a hawkish stance to a dovish tone.

DXY INDEX PRICE CHART: 240-MINUTE TIMEFRAME (DECEMBER 17, 2018 TO JANUARY 10, 2019) (CHART 2)

Fed Flexibility and Powell Patience Calms Market Angst

The selloff in the USD was worsened by the Federal Open Markets Committee meeting minutes release yesterday which detailed language much more dovish than originally indicated by the prepared statement presented by the Chairman at the conclusion of their meeting on December 18. However, most of the damage had been done when Powell spoke in a joint interview with ex-Fed Chairs Janet Yellen and Ben Bernanke last Friday leading the stock market to rejoice on the prospect of the Fed hitting the brakes on future rate hikes with equities staging a strong rally since.

US S&P500 INDEX PRICE CHART: 15-MINUTE TIMEFRAME (JANUARY 04, 2019 TO JANUARY 10, 2019) (CHART 3)

Fed Flexibility and Powell Patience Calms Market Angst

Powell reassured investors that the economy is on solid footing as he boasted strong employment, healthy consumer spending and stable inflation close to target as favorable tailwinds and reasons why the US economy should remain on a stable footing throughout 2019. Furthermore, Powell calmed Wall Street’s nerves by insisting that the Fed is not on a preset policy course and that the central bank can remain patient and flexible as it reads incoming economic data while “sensitively” listening to the markets’ concerns.

Highlighting the transition from hawk to dove, however, is Powell and the Fed’s supposed willingness to explore the tapering of its balance sheet currently running on autopilot rolling off $50 billion worth of assets a month. The Fed’s balance sheet ballooned in response to the financial crises from about $1 trillion to roughly $4 trillion where it stands now.

While Powell adamantly states that the Fed wants to reduce the size of its balance sheet, central bankers are reportedly open to and would not hesitate to change its current normalization process. Today he said to expect the balance sheet to be smaller than it is currently but larger than it was pre-crisis. Again, these developments had already been known and largely priced in by markets hence the muted reaction in the USD and SPX.

Written by Rich Dvorak, Junior Analyst for DailyFX

Follow on Twitter @RichDvorakFX

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