Breaking: Pound to Dollar Rate Surges as US Fed’s “Doves Land”

The pound to dollar exchange rate (GBPUSD) has bounced by an eye-opening 0.8% in the wake of the US Federal Reserve’s March policy meeting.

At the time of writing GBP/USD is at 1.4271 ensuring much of this week’s weakness is reversed.

The bounce by sterling against the dollar is mirrored elsewhere in the currency markets with the euro rising by over a a percent to trade above 1.12.

The FOMC turned out more dovish than expected as even though the statement acknowledged the macro improvements seen since January, it remained cautious with regards to its pace and again took into account global financial and macro developments for its decision-making.

In line with expectations, the forecasts delivered regarding the economy were little changed but conveyed lower growth and inflation expectations for 2016). 

The infamous 'dot plots' were revised downwards as they portrayed an excessively aggressive tightening cycle.

However, consensus was expecting a revision to 75bp in hikes during the year but the range of 0.5-0.9% as the estimated year-end Fed funds rate implies from one to two additional hikes.

“Investors punished the dollar because Janet Yellen failed to emphasize that 2 more rate hikes are expected this year and instead spent the large part of her testimony talking about the troubles in the U.S. and global economy,” says Kathy Lien at BK Asset Management.

The whole estimate for the Fed funds rate was revised downwards (i.e. the majority of FOMC members now expects a terminal rate in the range of 3.00%-3.25% vs. 3.5%-4.0% in December).

“The press conference was even more dovish, with heightened concerns over the global macroeconomic outlook, the inflation forecast biased to the downside and emphasis on a low long-term rate with a gradual pace of normalisation,” says Ociel Hernández Zamudio at BBVA Bank.

Why US Dollar Losses Could be Limited

We have seen the USD fall, but what of the outlook?

BK Asset Management’s Lien says there are two reasons to believe falls in the Greenback will likely be limited:

1) The Fed is still looking for 2 more rate hikes this year, which is 2 more than any other major central bank.  Janet Yellen talked a lot about how the dot plot reflects individual views that and noted the considerable uncertainty in each participant's forecast.  

2) Yellen said the forecasts aren't a preset plan, commitment or promise of action.  By downplaying the significance of the dot plot, she implies the potential for more or less action from the Fed.

“While this could be interpreted to mean that the Fed could forgo raising rates completely in 2016, her expectation that U.S. growth will run above potential, her view that every meeting including April is live for tightening and their decision to provide no guidance on the balance of risks suggests that there's still support for tightening in 2016,” says Lien.

Indeed, Fed President George voted for a rate rise this month. 

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