US Dollar: Fed reaction function clouds dollar outlook – MUFG

MUFG’s Derek Halpenny says the Fed’s decision to hold rates, combined with Chair Warsh’s unclear justification, steepened the Treasury curve and weakened the dollar. Rising inflation expectations and concerns over Federal Reserve (Fed) credibility now point to further depreciation risk.

Fed uncertainty weighs on Dollar

"The long-end of the US Treasury bond market sold off last night taking the US dollar weaker as well as Fed Chair Warsh spoke in detail for around 45mins but without providing any clear explanation as to why the FOMC decided to keep the key policy rate unchanged."

"We see three explanations here : 1) This potential more laissez-faire approach from Warsh means a less active Fed that will therefore, increase risks of the Fed ending up behind the curve. 2) Warsh mentioned that part of yesterday’s discussion related to assessing the degree of stimulus coming from the balance sheet. If this is being debated now investors will likely need to incorporate a bigger risk of a sooner adjustment in the size of the balance sheet; and 3) Is Warsh more ideologically opposed to rate hikes than previously assumed?"

"The bond market sell-off undoubtedly wasn’t helped by President Trump’s comment as the press conference ended that “Warsh would love to see lower rates”. Political influence and a divided FOMC between the Board of Governors and the Presidents will concerns investors."

"The 2s10s spread has had its biggest jump since August last year and we would argue the outcome of the Fed meeting is certainly US dollar negative."

"Fed credibility is being questioned today and after a big jump in inflation expectations the US dollar outlook has certainly worsened."