Are Powell's Rate Comments a Game Changer for the US Dollar?

The big story in the FX market today was the sharp sell-off in the U.S. dollar. The greenback fell quickly and aggressively after Fed chair Jerome Powell surprised investors by saying that interest rates are "just below" neutral levels. This view represents a significant departure from his comments back in October when he said they are a "long way from neutral at this point." Considering that there's been no interest rate hikes since September, these comments tell us one of two things, which is that the Fed has finally figured out where the neutral rate is or they believe that a pause in tightening has become necessary. Chances are it's the latter because economic data has been weakening, stocks have been falling and lower oil and gas prices restrict rather than encourage inflation. As a result, consistent rate hikes are no longer necessary. FX traders were not the only ones caught by surprise as equity investors rushed to cover their shorts, triggering the strongest one day rally for the Dow 8 months. The more than 600 point increase helped to drive high beta currencies such as EUR, AUD, NZD and GBP significantly higher.

Were today's comments are truly a game changer for the U.S. dollar and stocks?There's no doubt that Federal Reserve Chair Powell is adopting a less hawkish stance on monetary policy. Although he believes that the economy will continue to grow at a solid pace with low unemployment and inflation around 2%, his comments in the context of the recent performance of stocks and US data suggests that he thinks moving too quickly could risk shortening the US expansion. In many ways Powell is stating the obvious by saying what the market is starting to feel already. At the beginning of this month, Fed fund futures were pricing in a rate hike in December followed by a pause until March. Today, those expectations did not change by much as investors are still looking for a hike in December and a break until the spring or summer. In fact with the odds for second hike in March at around 40% and 56% in June, the curve is only pricing in one full rate hike for 2019 versus the Fed's forecast for 3 hikes next year. However this was also the prevailing view in the beginning of November, which means Powell's comments did not have a dramatic impact on market expectations. Yet by confirming what investors felt was necessary, he gave FX traders a strong reason to sell the overbought dollar and buy back stocks that have fallen steeply over the past two months.

Powell's comments could be a game changer for the U.S. dollar but its important to realize that the external factors driving other currencies lower have not changed.The Eurozone is still experiencing slower growth and recent comments from ECB President Draghi have been dovish. China is still embroiled in a trade war with the US and the risk of a no-deal Brexit is hampering demand for sterling. But more often than not the market's appetite for US dollars determines the broader trend for other currencies. Powell is not the only Fed President that is worried about tightening too quickly. If his concerns turn into a more consistent message from the central bank and alters the tone of the next FOMC statement, investors could officially kiss the dollar rally goodbye. Tomorrow's personal income, personal spending and FOMC minutes will be an important test for the greenback. If these reports fall short of expectations or the minutes contain an air of caution, traders will latch onto them quickly as an excuse to sell dollars more aggressively.