Why the Fed changed direction but the dollar did not

Many market players in the FX markets have been mistaken by greenback’s resurgence, which has taken place despite a sudden policy move from the Federal Reserve. Spooked by last year’s market turbulence, the US central bank made a U-turn in January, and in March went as far as shelving plans to hike interest rates at all this year. The ebb and flow of global growth and monetary policy generally influence exchange rates, and such a move would typically sap a currency of its vim and vigour.

Yet the dollar has been resurgent because of the resilience of the US economy and the still-high interest rates relative to the rest of the world and a scramble by other central banks to match the Fed’s sudden dovishness. The DXY index – which measures the dollar’s strength against a basket of other major currencies – last week powered to its highest level since May 2017. The euro, its most-traded counterpart, has skidded to a two-year low. In effect, it’s as if the Fed was the first to shift and the rest of the world is playing catch-up.

The most notable move beyond US borders has been from the European Central Bank, which in March signalled that the prospect of higher rates remains a long way off, even as growth has shown signs of picking up. The ECB’s deposit rate still lies in negative territory, at minus 0.4 per cent, contrasted to the 2.5 per cent top band of the Fed’s short-term interest rate. Some traders have been betting that the next move in interest rates from the Fed may be down rather than up, given weak inflation data. But with the economic growth rate coming in at a forecast-beating 3.2 per cent in the first three months of the year, analysts contend that this looks premature.

Employment data due on Friday, they say, could ease concerns over an impending cut in US rates, which endure the highest in the developed world. For now, however, the resurgent US currency is presenting a hazard to emerging markets, many of which depend on dollar support and remain susceptible to shifting exchange rates. The perennial weak links Argentina and Turkey have been affected since the turn of the year. Meanwhile, the Argentine peso and Turkish lira are now the worst performing major currencies of 2019, losing 13 per cent and 11 per cent respectively against the dollar.