The greenback was dragged down across the board even as the Fed sought to hike rates by 50 bps yesterday.
It's all about expectations as the rates market had previously aggressively priced in this latest tightening cycle by the Fed for the most part. The most evident reaction causing the drop in the dollar is the retreat in 2-year Treasury yields, after Fed chair Powell said that they will not move as aggressively to hike by 75 bps in subsequent meetings.
That may be a big signal that we may see peak hawkishness start to settle in. If that is the case, what comes next for the dollar?
At this point, the Fed has outlined a push towards 2.00% to 2.50% in the Fed funds rate and given the move in rates since the turn of the year, I'm inclined to believe that is something that markets will be able to stomach or at least have the appetite to deal with as we go through the process until year-end.
Instead, the key focus will be what will the Fed do next after we have gotten to that point?
If inflation remains a major problem and the economy holds up, we could see further rate hikes to try and address the issue. But if stagflation risks mount and the economy is headed for a more protracted slowdown, that is going to be an issue for the Fed. As such, they may have to climb down on rates just as soon as they have hiked during this cycle to combat inflation.
That turn will be a considerable headwind for the dollar surely.
The greenback is finding more steady footing on the day so far but it is not too far a reach to believe that if we are seeing peak hawkishness by the Fed, we are also perhaps seeing peak hawkishness in the dollar as well.
I would argue there's going to be some push and pull in the days ahead to try and settle the debate. The dollar is no doubt still in a good spot and the bond market remains one to watch in spite of the Fed. 10-year Treasury yields are still at 2.94%, just shy of closing in on the 3.00% mark so that is still something to be wary about.
