The market reaction on Thursday has been fairly surprising, as two major elements of uncertainty that have driven down equities in the past haven’t stopped a stock market rally. This is important for Forex, not just because it shows a resurgent risk appetite, but also a shift in market focus. That can be best illustrated by the dollar weakening despite the Fed taking on a more hawkish stance on Wednesday.
Normally, an increase in the chances of a rate hike strengthens a currency, because it attractis investors who want to profit from the rate differential. However, dollar strength in the last couple of months had more to do with markets seeking safety amid geopolitical uncertainty. Markets are adjusting to the new normal, and there is increased uncertainty about the direction in the Fed.
The Fed’s Market Surprise
The FOMC decided to keep rates unchanged on Wednesday, as was widely expected. However, there were four dissenting votes, the highest number since 1992, which caught many traders by surprise. One of those votes, from Stephen Miran to cut, was widely expected. The other three came from hawks, who approved of the hold, but disagreed with the languaged being used in the monetary policy statement. They wanted to remove a passage that implied a certain amount of dovishness in future policy.
Normally, FOMC votes are unanimous, and it’s very rare to have dissenting votes. But they have become much more normal in the final months of Fed Chair Jerome Powell’s tenure, highlighting growing division in the central bank. That division is expected to continue under the new Chair, and could have another point of contention: Jerome Powell himself.
Powell To Stay on As Governor
At his last post-rate decision press conference, Powell clarified that he would stay on as Governor when his appointment as Chair expires on May 15th. Normally, when a Fed Chair’s tenure his over, they resign as governor to pursue other activities (usually an academic appointment, like both Yellen and Bernanke). Part of this is due to the Chair not wanting to go back to a “lesser” post, but also to clear the way for the new Chair to set the tone.
It also means that the President gets to appoint a new Governor, which is a touchy issue in the current environment. It’s widely expected that US President Donald Trump would appoint a dove, like Miran and Warsh. Powell is comparatively hawkish, and his staying on is interpreted as a sign of defiance and attempt to keep the Fed from cutting rates. He could provide a figure that dissenters might rally around, dividing the Fed.
The Odds of a Cut Change
Following the Fed’s meeting, the odds of a rate cut by the end of the year went from about 30% to practically nil. Instead, markets are pricing in around a 20% chance of a rate hike. That’s a substantial hawkish shift.
Part of the move can be attributed to higher energy prices, as crude oil rose to its highest level in years. Even if Trump-aligned officials wanted to cut rates, higher inflation would prevent the move. Ironically, high inflation could foster unity within the Fed and increase certainty. But if oil prices come down, and there appear to be “factions” forming within the FOMC, markets could have to deal with growing monetary policy uncertainty. Most likely, this would be negative for the dollar.
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