The dollar tumbled after the Fed rate hike (Daily analysis 23.03.2023)

The Federal Reserve raised interest rates by 25 bps, to the highest level since 2007 of 4.75-5.00%. However, this does not mean that the US monetary authorities are indifferent to the threat of a banking crisis. On the contrary, the belief has been firmly established among investors that the hike cycle is at an end and easing is just around the corner. As a result, the dollar dropped, and the EUR/USD rocketed to 1.09, the highest level since the first days of February.

US dollar: the Fed hike cycle is coming to an end

Yesterday, the Fed highlighted that the collapse of Silicon Valley Bank and the troubled regional financial institutions would lead to a reduction in lending across the entire economy. Banks will provide loans more cautiously, and their cost will be higher. Therefore, the consequences of recent events will be similar to interest rate rises. As a result, the wording on the FOMC's future steps was softened in the communication accompanying the decision.

Furthermore, at the press conference, Jerome Powell admitted that refraining from an increase was a scenario under consideration. Significant for the trading course is also the declaration by Treasury Secretary Janet Yellen that an extension of the bank deposit guarantee mechanism above 250,000 USD is not under consideration. As with the SVB, this could happen if a systemic risk is identified. This has hit sentiment on Wall Street particularly hard but is also having an impact on the dollar's perception.

Dollar: USD plunges as the market believes in a quick rate cut

Back to the Fed: the US central bank's assessment of its intentions outlook in six weeks has circled around. The Fed's December forecasts assumed that it would need to raise interest rates above 5% and maintain the restrictive policy for a long time this year to combat persistent inflation. Investors began to believe in such a scenario only after a series of data confirmed the strength of the US economy, which will make it difficult to subdue dangerous price pressures. A fortnight ago, the Fed chief emphasised during a report in Congress that stronger tightening was necessary. The increased likelihood of interest rates reaching the vicinity of 6% put wind in the dollar's sails.

The belief in the inevitability of the Fed maintaining a tight rate lay in ruins with the emergence of tensions in the banking sector. FOMC members maintained forecasts that rates should be above 5% by the end of this year, and the Fed chief yesterday pushed back against rate cuts. Nevertheless, investors are pricing in the chances of a hike in May to be less than 50% and expect the cost of money to be cut by 50-75 bps in the second part of the year. This would be consistent with the Fed's behaviour in the past.

After the last five cycles of hikes, policy easing has started on average eight months after the final upward rate move. While this time, due to persistent core inflation, may be different, this should not become a dollar asset in the near term as the European Central Bank maintains a decidedly more restrictive stance. We expect the EUR/USD to return permanently above 1.10 this year.