Fed Rate Cuts are Coming, So Why Didn't the Dollar Crash?

Regardless of how the US dollar reacted to the Federal Reserve's monetary policy announcement, the main takeaway is that lower interests are coming. Instead of talking about the possibility of rate cuts, the conversation has shifted completely to the speed of easing. Back in March 2 members favored a rate hike in 2019 and 11 favored no change. Now, only 1 member favors a rate hike while 8 see rate cuts in 2019. The worst part for the dollar is that 7 of those 8 members see the need for 2 rounds of easing. St Louis Fed President Bullard wanted interest rates to be lowered by 25bp today.

So we did not even need to hear from Federal Chairman Powell to understand how dovish the central bank has become over the past 3 months because the dot plot alone speaks volumes about how dramatically sentiment inside the Fed changed.Inflation is easing and uncertainty is rising and business investment is slowing. Even though the Fed upgraded its 2019 GDP forecast and lowered their unemployment rate projections, their next move should be a rate cut and not a hike. The Fed also removed the word "patient" from the FOMC statement, which was originally expected to be hawkish, but now it's seen as a sign that they won't wait long before easing. Yet Federal Reserve Chairman Powell still put on a brave face and described the labor market as strong and said incoming data is good especially on the consumer level. However it won't take much to tip them over the edge. According to Powell, they "expect to learn a lot more about the risks in the near term" and if data or the risk picture worsens, they have enough support within the central bank to ease quickly.

In a nutshell, here are the 6 main things you need to know about today's Fed meeting.

1. Fed leaves interest rates unchanged and drops the word "patient" from policy statement
2. For the first time, Dot Plot signals interest rate cut - 8 out of 17 members see rate cut this year (7 of those favor 2 rate cuts)
3. Fed is worried that inflation, manufacturing activity, trade and business investment will fall further
4. Lowers inflation projections, upgrades GDP and unemployment rate forecast
5. Job creation and consumer spending won't be enough to offset downside risks
6. But Fed wants to see more & they expect to learn a lot more from incoming data and risk picture in the near term

The US dollar fell across the board after the FOMC statement and dot plot forecast was released but failed to extend lower on the back of Powell's comments because the Fed Chair downplayed their urgency to ease. He made it clear that they are in wait and see mode but at the end of the day all of the changes to the FOMC statement is negative for the dollar. The Fed may be waiting for more data before lowering interest rates but it won't take much to push them into action - one or two months of disappointing CPI or NFP numbers will be enough. We believe that the dollar should be headed lower against the JPY, CHF and CAD but losses against EUR, AUD and NZD should be limited by the dovish bias of those central banks.

The action continues with the Bank of England's monetary policy announcement tomorrow. Unlike the ECB or other major central banks, recent comments from Bank of England officials cannot be described as dovish. Everyone is worried about a no-deal Brexit but a number of policymakers including Deputy Governor Broadbent and policymaker Saunders feel that rates may have to rise faster than the market expects. This is a view also shared in the past by Governor Carney because the central bank's base case (and ours as well) is for a smooth Brexit. According to the table below, there hasn't been any clear direction in the economy since the policy meeting. If the emphasis is on rate hikes, sterling could hit 1.28 versus the dollar and .88 cents versus euro. However if they follow in the Fed's footsteps and raise the possibility of easing, GBP should fall to fresh year to date lows against both currencies.