The strength in the U.S. Dollar Index on Thursday should not be interpreted as a sign of a hawkish Fed. The index is heavily weighted in the Euro so when the Euro weakens substantially, the dollar index rallies. This is a hard concept for Forex traders to comprehend at times, but if you don't understand the relationship, you're likely to get burned in the markets.
I interpreted the Fed as dovish because it dropped the word "accommodative" from its monetary policy statement and Federal Chairman Powell downplayed the fear of inflation spiking to the upside.
In my opinion, removing "accommodation" means there is no preset path of rate hikes and every Fed meeting moving forward becomes a toss-up. While being accommodating, at least the Fed said it would remain on a path to gradually lift rates. By not being accommodating, it reserves the right to raise rates if it wants to or take a pass on a rate hike. This is dovish in my opinion.
Additionally, despite the Consumer Price Index ( CPI ) and the PCE pointing at rising inflation as well as increasing average hourly earnings, Fed Chairman Jerome Powell said he does not see a buildup in fundamental inflation and does not anticipate prices surprising to the upside. This tells me that Powell feels inflation is somewhat under control so perhaps the Fed won't have to be as aggressive to tame it. Once again, I interpret this to be a dovish sign.
If you believe that the Fed was hawkish because they raised interest rates, forecast additional rate hikes and presented estimates of future economic growth then take another look at your reasoning behind this way of thought.
If you took a class in Futures 101 then you should know that the futures markets discount future events. And if you are a regular reader of my analysis then you should know that I believe everything in the financial markets begins with U.S. Treasury yields. They set the tone and direction.
The rapid plunge in the benchmark 10-year U.S. Treasury yield since August 22 should have told you that yesterday's 25-basis point rate hike had been priced into the market for over a month. So essentially, yesterday's Fed activity became a sell the rumor, buy the fact situation.
Furthermore, as far as the economic reports are concerned, I ask you to show me where they changed from the previous reports. Once again old news.
Putting it all together, we had a widely expected rate hike, the removal of the word "accommodative" and a Fed Chair who has no fear of a spike in inflation. These factors add up to a dovish Fed.
U.S. Dollar Rally
I know you are asking, "If the Fed was dovish then why is the U.S. Dollar stronger today?" Firstly, the Fed statement is already old news. Secondly, the Euro is weaker and as I said before, when the Euro weakens, the dollar index rises simply because of its weighting in the index.
The Euro is being pressured because of geopolitical turmoil in Italy. Investors fearing an escalation of problems are shedding risk. Investors learned during the Greek debacle and the financial crisis of 2009 that it is better to sell the currency with the most exposure first and ask questions later.
The Fed rate hike isn't making the Euro weaker. Once again, it was a known event. In fact, U.S. Treasury yields are falling today because investors fearful of an escalation of problems in Italy are moving money into safe-haven Treasurys.
Furthermore, despite the drop in interest rates, the U.S. Dollar Index is rallying because the greenback too has become a highly desired safe-haven asset.
If you're a longer-term investor then today's events are just noise and the Fed's actions are more important to direction. If you are a short-term investor or trader then forget about the Fed and focus on the news. If you think you can trade both scenarios then good luck.
This article was originally posted on FX Empire
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