Fed’s Dovish Stance Shoots Up Greenback to Three-Month High

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Summary

• The US dollar recently hit a three-month high level after the Fed Chair delivered a dovish message on bond markets in his latest speech.
• The rise in the greenback came as the 10-year Treasury yield inched above 1.5 per cent on Thursday.
• Following the Fed Chair’s remarks, riskier currencies like New Zealand and Australian dollars slumped along with equities.

Giving an end to growing speculations that the US Federal Reserve will pull back policy support earlier than expected, Fed Chair Jerome Powell recently reiterated the central bank’s policy stance is appropriate. Powell further failed to express concern over a recent surge in the government bond yields in his recent speech, pushing the US dollar to its three-month high level.

Following the Fed’s Chair dovish message, the US Dollar Index (DXY) touched as high as 91.663 on Thursday, reaching its highest level since 1 December 2020. Continuing its gains, the index was trading at 91.70 at 1:20 AM EST on 5 March 2021.

Furthermore, the greenback hit multi-month highs against the yen and the euro during the early trading session on Friday. The safe-haven currency touched an eight-month high of 108.035 yen earlier in the Friday session before laying off much of its gains.

USD Gains on Jump in Bond Yields

The gain in the greenback came as the US government 10-year bond yield bounced back above 1.5 per cent on Thursday, soaring as high as 1.584 per cent in Asia. Last week, the yield on the US 10 Year Treasury Note climbed to the one-year peak of 1.61 per cent.

As the Fed Chair emphasized that the central bank was focused on broader financial conditions than bond yields per se, the yield on the 10-year Treasury note crept higher.

Powell highlighted that sharp moves in the bond market last week did catch his attention and were notable, but he would be concerned by disorderly circumstances or a persistent change that endangers the Fed’s goals and makes credit expensive. In other words, the Fed Chair did not see the recent rise in bond yields as a matter that needs the central bank’s forceful intervention in markets to bring them down.

Must Read: How Bond Yields are Driving the Forex Market

Over the recent weeks, the bond yields have advanced to new highs on increasing expectations of faster inflation and robust economic growth in the post-COVID era. Expectations of higher inflation have been making investors jittery over how long the US Fed and other Reserve banks could keep interest rates down.

The impending US$1.9 trillion stimulus package and the COVID-19 vaccination drive fuelling economic recovery hopes further delivered a leg up to a rise in bond yields, stimulating demand for the greenback.

Riskier Currencies Experience Fall

While Powell’s remarks reignited the demand for the US dollar, riskier currencies like New Zealand and Australian dollars fell along with equities.

The Australian dollar slid against the greenback despite the recently released better than expected December 2020 quarter GDP data. Extending Thursday’s 0.7 per cent drop, the Australian currency weakened 0.3 per cent to 77 US cents on Friday. The AUD/USD pair is currently holding below its three-year highs of $0.8007 touched last week. Akin to the Aussie, the New Zealand dollar also firmed slightly after Fed’s speech.

Besides Aussie and kiwi, Wall Street and the global stock markets also slumped on Thursday after Fed’s remarks. The S&P 500 index that was over half a per cent up earlier during Thursday plummeted into negative territory — ultimately closing with its third consecutive day of fall.

Outlook

Buoyed by a further stimulus on the one hand, or economic recovery on the other, the broader picture for equities seems positive in the coming year.

Besides, the commodity-linked currencies (kiwi and Aussie) are also expected to resume their uptrends in the near future amid their solid recovery from the coronavirus pandemic. Meanwhile, the pace of global vaccination is expected to decide the fate of greenback in the coming year.

Also Read: How Bond Yields impact an economy