US Dollar Strengthens as Federal Reserve Hints at Rate Hikes; Japanese Yen Weakened

The US dollar experienced a significant boost following indications from the Federal Reserve about potential rate hikes later this year, despite the central bank's decision to keep interest rates unchanged. All eyes are now on the imminent policy announcement by the European Central Bank later today. This article explores the repercussions of the Fed's recent decision, examines the market's response, and provides insights into upcoming policy decisions by major central banks.

Breaking its streak of ten consecutive rate hikes, the Federal Reserve's choice to maintain the current interest rates caught the attention of market participants. However, the dot plot projections unveiled by policymakers hinted at the possibility of two additional rate increases by the end of 2023. Federal Reserve Chair Jerome Powell emphasized that rate cuts in 2023 would not be deemed appropriate. Jefferies' Chief Financial Economist Europe, Mohit Kumar, characterized the Fed's move as a "hawkish skip" and expressed surprise over the more aggressive revision to the dot plots.

Following the announcement, the dollar index, which gauges the greenback against a basket of major currencies, rebounded by 0.2% to reach 103.09, recuperating from its four-week low of 102.66 recorded on Wednesday. Market attention has now shifted to the eagerly awaited policy announcement by the European Central Bank later today, as market participants seek clarity on future monetary policy directions.

The euro, on the other hand, maintained relative stability against the dollar, trading at $1.0841, after peaking at a four-week high of $1.0865 on Wednesday. Money market traders are anticipating a 25-basis-point increase in the ECB's deposit rate, with a further quarter-point hike anticipated in July.

Kristoffer Kjær Lomholt, the Head of FX and Corporate Research at Danske Bank, pointed out that market expectations surrounding the ECB's communication on risk balance and the need for future rate hikes may result in reduced market volatility compared to previous ECB decisions. Lomholt also highlighted the attractiveness of the US economy compared to the euro zone, making the dollar a more appealing currency choice for investors.

Looking ahead, market participants are eagerly awaiting the policy decision of the Bank of Japan, scheduled for Friday. It is widely anticipated that the Bank will maintain its current ultra-dovish stance and yield curve control settings, although hints of an upcoming policy shift will be closely scrutinized.

The Japanese yen faced a significant decline, reaching its lowest level against the dollar since November, with the exchange rate touching 141.50 yen per dollar. Market analysts are now vigilant for any indications of currency intervention by the Bank of Japan, either through verbal or effective measures, as the yen's downward trajectory raises concerns.

Meanwhile, the New Zealand dollar weakened by 0.6% against the dollar, trading at $0.6172. This decline was fueled by the release of data indicating that New Zealand's economy entered a technical recession in the first quarter, casting doubt on the likelihood of future rate hikes.

China's offshore yuan touched 7.1916 per dollar, its weakest level since November, following the People's Bank of China's surprising decision to cut the borrowing cost of its medium-term policy loans for the first time in ten months. Currently, the yuan stands at 7.1619 per dollar. Analysts anticipate a reduction in China's benchmark rates next week, in addition to the recent cut in the PBOC's short-term policy lending rate.

With expectations rising for broader stimulus measures aimed at boosting the Chinese economy, Sim Moh Siong, a currency strategist at the Bank of Singapore, emphasized the significance of the rate cut earlier this week. Traders and investors will closely monitor developments surrounding China's economic policies as they unfold.

Also Read: US Dollar Struggles as Unemployment Claims Surge; Market Anticipates Fed's Next Move