US Dollar: Higher rate expectations support gains - Commerzbank

Commerzbank’s Thu Lan Nguyen discusses how the US Dollar (USD) reacted to Federal Reserve Chair Kevin Warsh’s move away from traditional forward guidance. She notes that initial unease gave way to a stronger Dollar as rate expectations rose, arguing that central bank credibility and commitment to its inflation mandate matter more than the specific communication toolkit used.

Fed guidance, credibility and Dollar

"Against this backdrop, it is understandable that markets reacted uneasily over the summer when Warsh put his words into practice and deliberately refrained from providing clear guidance on the future path of interest rates. The dollar came under pressure as market participants struggled to interpret the new Fed Chair's intentions. More importantly, this probably fuelled concerns that the US administration might be influencing Warsh in order to keep interest rates artificially low."

"Since then, however, the picture has changed completely. US rate expectations have moved markedly higher, and the dollar has recovered. Yet Warsh has not altered his sceptical stance toward forward guidance."

"In my view, the episode demonstrates one thing above all else: what ultimately matters is not the specific toolkit used by a central bank, but its credibility. If markets are convinced that a central bank is committed to fulfilling its mandate, questions about the precise (communication) strategy become secondary. What matters is the belief that the institution will take whatever action is necessary to achieve its (inflation) objective."

"The Fed reinforced precisely this confidence with last month's rate hike. Notably, Warsh himself supported the decision. As long as markets believe that the Fed will make the right policy choice when it matters most, they appear willing to overlook the fact that the Chair is reluctant to commit to a specific future path for interest rates."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)