Given yesterday’s decision of the US Federal Reserve not to raise interest rates, US dollar weakness for 2019 is on track. The Fed decelerated monetary policy and its tightening path, and it gave a very strong signal that interest rate cycle is finished. Fed Chairman Jay Powell shifted course, becoming dovish on policy rates and flexible on balance sheet reduction. Given the resilience of the US economy, the Fed has surrendered to market volatility. The Fed only slightly downgraded its growth outlook, stating that the economy is expanding at a “solid” pace versus “strong.” What is it with central banks and market volatility? Markets matter, and they directly influence central banks, even the detached Fed.
Risky assets rallied across the board, while the greenback fell. A March interest hike is completely off the table, and one in June is unlikely. A September hike is expected by only the thinnest of probabilities, then nothing in 2020. This sets a final target of 2.50-2.75% for this tightening cycle. We expected the Fed’s balance sheet to normalize around $2.0-2.5 trillion, which implies excessive reserves of approximately $2 trillion. Managed reduction of the balance sheet should help cool US inflation while not affecting risk appetite.
By Peter Rosenstreich
