Dollar falters as Fed dashes early U.S. rate hike view

NEW YORK (Reuters) – The U.S. dollar fell on Wednesday, after the Federal Reserve said it does not expect to raise interest rates through all of 2023, contrary to market expectations.

FILE PHOTO: U.S. one dollar banknotes are seen in this illustration taken February 8, 2021. REUTERS/Dado Ruvic/Illustration

The dollar index dropped 0.5% to 91.405 after the Fed comments.

The greenback had reversed its slide in recent sessions on a surge in U.S. Treasury yields due in part to growing expectations that the Fed may tighten rates earlier than thought on forecasts of a faster-than-expected economic recovery.

U.S. benchmark 10-year Treasury yields hit a 13-month high early in the session but was last at 1.647%.

In a statement after the Fed held interest rates steady, the U.S. central bank said it expects a rapid jump in U.S. economic growth and inflation this year as the COVID-19 crisis winds down, and vowed to keep its target interest rate near zero for years to come.

That was in contrast to what the eurodollar futures market suggested before the Fed statement, almost fully pricing in a rate hike by December 2022 and three increases in 2023.

While the improvement in the Fed’s economic outlook did not immediately change policymakers’ expectations for interest rates, the weight of opinion did shift. Seven of 18 officials now expect to raise rates in 2023, compared to five in December.

Fed Chairman Jerome Powell, in a press conference, also said the U.S. central bank it’s not looking at dates to reduce its asset purchases just yet.

Had Powell hinted at possibly tapering its bond buys, that would have caused a much sharper bond sell-off and a further spike in yields which would have pushed the dollar higher.

“Bringing forward the median forecast for the first-rate hike into 2023 wouldn’t have fitted Fed Chair Jerome Powell’s narrative,” said ING in a research note.

“Signalling an earlier move would have given more ammunition for the bond market to push yields significantly higher just when Powell has been indicating his concern that ‘disorderly conditions in markets or a persistent tightening in financial conditions that threatens the achievement of our goals’.”

After the Fed statement, eurodollar futures pared back bets on an interest rate hike by December 2022. It has priced in so far a 90% chance of tightening by March 2023, but still showed three hikes for the whole of that year.

The euro rose 0.7% against the dollar to $1.1978.

Against the yen, the dollar fell 0.1% to 108.87 yen.

That said, analysts do not see the Fed statement as a catalyst for the resumption of the dollar’s weak trend seen at the beginning of the year.

“I don’t think this is necessarily going to return the dollar to a downtrend,” said Mazen Issa, senior currency analyst at TD Securities.

“In order for that to resume the euro needs to gather upside momentum. The European economy is very far from matching growth expectations in the U.S.”

(This story refiles to insert dropped words in 9th paragraph)

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