Fed did not raise rates Wednesday. But what Warsh said after the meeting was enough. Dollar is now at its strongest level in over a year and rivals are feeling the pressure across the board.
Dollar Breaking Out
Dollar index pushed above 101.10 Friday morning. That is the highest intraday level in more than a year. The index had been stuck in a frustrating range for weeks without a clear direction. Wednesday’s Fed meeting broke it out of that range.
Rates did not actually change. Fed kept them at 3.5% to 3.75%. But the message that came with the decision pointed toward tighter policy ahead. Markets took that seriously and the dollar moved.
In currency markets expectations do more work than actual decisions most of the time. Traders do not wait for rate hikes to happen. They position for them weeks or months in advance. Wednesday gave them enough to start positioning heavily in favor of the dollar and that is exactly what they did.
Rate Hike Is Now Priced In for October
Fed funds futures are now fully pricing in a rate increase by October. That is a meaningful shift from where expectations were just a week ago when rate hike probability was below 50%.
Retail sales data that came out this week added to the case. Numbers came in stronger than expected. Strong consumer spending tells the Fed the economy can handle tighter policy without breaking. That removes one of the main arguments against hiking.
Nearly half of Fed policymakers now see at least one rate hike happening before year end according to the updated dot plot. Warsh himself did not submit a dot but the committee around him is leaning hawkish. Hawkish means inflation is the priority. Easier money is not coming anytime soon. That environment is good for the dollar.
Yen Is Back Under Pressure
Japanese yen weakened to 161.80 per dollar on Friday. That erases the gains that came from Japan’s large intervention effort earlier this year. Back to levels that made authorities nervous enough to step in once before.
Japanese government responded quickly. Chief Cabinet Secretary Minoru Kihara said officials are ready to act against excessive currency moves. Same language they used last time. Markets have heard it before and the question is always whether they back it up with actual intervention or just words.
Bank of Japan raised rates to 1% earlier this week. Highest level since 1995. Did not help the yen much. When US rate expectations are rising faster than Japanese rate expectations the yen tends to lose ground regardless of what the BoJ does. The interest rate gap between the two countries is still very wide and that gap is what drives the pair more than almost anything else.
Euro and Pound Both Down
Euro slid to $1.1420. That is near a three month low. European Central Bank is not signaling anything close to the hawkishness coming out of Washington right now. That divergence in policy direction pushes money toward the dollar and away from the euro.
Pound fell to $1.3180 after Bank of England left rates unchanged Thursday. Sterling has now dropped roughly 260 pips in just three days. Bank of England held rates at 3.75% which was expected. But with UK inflation cooling and economy slowing the BoE does not have a strong case for hiking anytime soon. That leaves the pound vulnerable when the dollar is strengthening on rate hike expectations.
Two members of the Monetary Policy Committee voted for an immediate hike but they were outvoted. That minority view is not enough to move the pound higher when the broader trajectory is pointing toward a prolonged hold.
Where This Leaves FX Markets
Dollar holding all the cards right now is the simplest way to describe it. Fed is leaning hawkish. Economy is showing resilience. Rate hike by October is priced in. Every currency that is paired against the dollar is dealing with a central bank that either cannot or will not match the Fed’s tone.
Yen has intervention risk hanging over it but intervention has limits. Euro has a central bank that is not in hawkish mode. Pound has a slowing economy that makes aggressive tightening difficult.
Iran peace deal signing today in Switzerland could shift some of this if it goes smoothly. Lower oil and easing geopolitical risk could take some inflation pressure off globally which would cool dollar strength slightly. But the Fed signal from Wednesday is now the dominant force in currency markets and one diplomatic signing is unlikely to fully offset it.
Dollar is in control of this conversation for now.