The Fed’s “Hawkish Pause”: A Fundamental Overview

As Alison and I discussed in our most recent podcast, this week was a big one in terms of fundamental changes to the Forex trading landscape. We had three major events: US inflation data release on Tuesday 13^th June, the US Federal Reserve’s interest rate decision on Wednesday 14^th June, and the European Central Banks’ interest rate decision today, Thursday 15^th June.

US inflation came in roughly around market expectations, with headline inflation coming in at 4% versus a 4.1% predicted. Core inflation was right on the money, with a 5.3% print. Both figures were major drops from previous months, showing that inflationary pressure on the US economy was easing.

Traders were emboldened by the data. The markets had previously predicted a pause in the FOMC’s campaign to bring down inflation via interest rate hikes, and the inflation data only strengthened their belief.

The EUR/USD tracked higher as a result, with EUR bulls taking firm control. Until the FOMC decision itself came through. What analysts are now calling a “hawkish pause” wrongfooted the markets. Yes, the Fed decided to hold interest rates steady, but it was the attached commentary which caused a temporary surge in the USD.

In his comments after the FOMC decision was published, Federal Reserve Chairman, Jay Powell, said:

“I think, as anyone can see, not a single person on the committee wrote down a rate cut this year — nor do I think it is at all likely to be appropriate if you think about it. Inflation has not really moved down. It has not reacted much to our existing rate hikes. We’re going to have to keep at it.”

But the surge in USD, as measured by the DXY index, was only temporary. The EUR bulls are back in control of the EUR/USD and it is clear that the markets do not believe that the Fed is going to continue hiking interest rates in the medium term, despite the hawkish rhetoric. As Jefferies Economist Thomas Simons says in a note:

“In the economic projections, growth was revised up and core inflation projections were also revised up, consistent with the ‘higher for longer’ implication of the dots. Our base case right now remains that the Fed is not going to hike rates further, but future rate hikes will depend on the tone of the incoming economic data.”

Which leaves us back at square one, in a reactive mode – traders, analysts and the Fed – all waiting on the next raft of data to tell us which way the wind is blowing.

The ECB rate decision is due out today, with markets pricing in a 98% chance of a 25bps raise in interest rates. With no significant surprises expected, we can expect to see the EUR bulls remaining in control and further pressure on the USD from all major currencies.