The Dollar gain is abnormally long-lasting and “should” get a pushback

Outlook: The WSJ first paragraph came in yesterday exactly as expected: “Federal Reserve officials voted to hold interest rates steady at a 22-year high but signaled they were prepared to raise rates one more time this year to combat inflation.” The Fed wanted “hawkish hold” and got it.

Any idea of a dovish interpretation of the pause was quickly extinguished by the dot-plots, which indicate that after the single additional hike this year, next year will see the cuts, but by a whole lot less than the market wanted or the hopeful expected—it will be two cuts, not four, and the year will end with 5.25%. The current year will end with 5.75%. Goldman Sachs says it now expects Fed cuts to be postponed until Q4 next year, when the expectation before yesterday was March, then June.

“Longer” just got longer. This may well be acknowledgement that rate hikes have been little more than a thorn in the side of businesses and consumers, who keep wildly investing and spending. In other words, as the smart Goldman analyst Hatzius says, "(Fed) participants appeared to move away from the view that monetary policy tightening could weigh on growth with a long lag next year, which weakens one argument for cutting."

And here is the same leave-the-door-open statement as last time: “In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

That’s really all we need to know—let the fights begin. But there is an improved growth forecast, too (2.1% GDP this year, from 1.0% projected in June). Core PCE inflation will have fallen to 3.7% by year-end. Wait a minute—where’s 2%? Not   until 2026. A ray of light—Powell said the Fed needs “convincing evidence” inflation is headed for the target! Aha. We await whether anyone else smells acceptance of something more than 2% if the momentum toward 2% is strong enough.

And still. The trend within the voting members minds is for more hawkishness when the dot-plots are compared to June. The dot-plot shows that 12 of 19 officials favor another rate hike this year. It looks like Mr. Powell has convinced more than the markets—he has convinced his own members.

One little thing more—the dot-plot expectation for unemployment is trivial—a rise in unemployment only to 4.1% over the next two years--from 4.5%. This is a tacit admission that the Phillips curve is outdated.

In the light of the Fed statement, today’s information looks stale before it comes out. Initial weekly jobless claims is likely a small rise over last time but lower over the past month and 4-week moving average. The Fed is looking for a sustained rise and getting the opposite.

We also get the Philadelphia Fed survey, existing homes (three guesses) and leading indicators.

Forecast: We always expect a brief pushback following a big trend move but perhaps not this time and instead a bit of confused rising and falling. We still think the dollar gain is abnormally long-lasting and “should” get a pushback, but it’s not happening just yet. That doesn’t mean it’s not in the cards. The thing to worry about now is not the fallout from the Fed hanging tough, but rather what the Japanese Ministry of Finance and Bank of Japan are thinking. They don’t want the dollar/yen to reach 150 again and while nobody can beat Japanese patience, nobody can beat their resolve once a decision is made.

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