22.05.202304:06 Forex Analysis & Reviews: EUR/USD. What did Powell say?

Federal Reserve Chairman Jerome Powell put pressure on the dollar at the end of the trading week. Powell spoke at a conference regarding the outlook for monetary policy. The theme of the event indicated that Powell could voice his stance on the future prospects of monetary tightening. These expectations were justified. In most cases, the head of the central bank is rather cautious in his statements, but in this case Powell, surprisingly, voiced very transparent hints.

And these hints did not sit well with the dollar bulls. On Friday, the US dollar index could not hold the high it had reached (103.49) and fell into the area of the 102nd figure (although then the greenback was able to regain some of the lost positions, ending the week at 103.07). Such a reaction is quite understandable, as Powell questioned the expediency of further interest rate hikes. Responding to such rhetoric, bulls managed to return to the area of the 8th figure, closing Friday's trading at 1.0804.

False growth of hawkish expectations

Before going back to Powell's speech, we should recall that the dollar strengthened its positions the previous week not only due to the rise in risk-off sentiment, but also due to the strengthening of hawkish expectations regarding the Fed's further actions. The recent statements of several Fed officials were clearly hawkish, supporting the greenback. Despite the slowdown in inflation in the United States, some central bank officials did not rule out further monetary tightening, lamenting the persistently high level of the core Consumer Price Index.

In particular, Dallas Fed President Lorie Logan said that the data points so far don't justify skipping a rate hike in June. This position was voiced in one way or another by other representatives of the US central bank - for example, Loretta Mester, Thomas Barkin, Raphael Bostic, and John Williams.

The market reacted to the toughening rhetoric in a corresponding manner: according to the CME FedWatch Tool, the probability of a 25-point rate increase in June rose to almost 40%. For comparison, it is worth noting that at the beginning of May, the chances of implementing a 25-point scenario were estimated at 5-8%.

Therefore, Powell's messages served as a "cold shower" for the dollar bulls.

A cold shower for dollar bulls

In essence, the Fed chair once again "highlighted" the relevance of the banking crisis in the US, linking recent events to the aggressive policy of the US central bank. Powell said that the recent banking crisis, which led to tighter credit standards, has eased the pressure to hike interest rates. In this context, he means that they may not need to bring the rate back to the previously planned value. To quote him verbatim, the phrase sounded like this: "our policy rate may not need to rise as much as it would have otherwise,". At the same time, he expressed concern about the consequences of the decisions already made. According to Powell, there is currently uncertainty regarding the delayed consequences of the measures already taken, as well as the degree of credit tightening as a result of the recent banking crisis.

As a "cherry on top" - a summarizing phrase from the Fed chair that the US central bank can now afford to assess the effectiveness of the measures taken, to draw conclusions about the future prospects of monetary policy.

I remind you that back in March, after the crash of the largest bank in Silicon Valley in the US (Silicon Valley Bank), and the subsequent bankruptcies of Signature Bank and Silvergate Capital Corp, First Republic, there were rumors that the Fed might refrain from raising interest rates at subsequent meetings. Moreover, some experts voiced cautious assumptions about a possible step back, in the context of a rate cut.

But contrary to dovish forecasts, the US central bank still raised the rate - both at the March and May meeting. Core inflation, which unexpectedly resumed its growth, forced the Fed to take countermeasures, despite existing risks.

As of today, judging by Powell's stance, the Fed is once again concerned that a further increase in the interest rate will cause a new wave of bankruptcies of American banks. By the way, the situation with PacWest is another "alarm bell" - another bank in the US is on the verge of closure.

Conclusions

The Fed head "sobered up" traders who were too gullible about the hawkish statements of some Fed representatives (many of whom, by the way, do not have voting rights this year). The likelihood of a rate hike at the June meeting has dropped sharply - from 40% (before Powell's speech) to 17% (after the speech).

Overall, the greenback has lost an important advantage. The dollar strengthened its positions thanks to two factors: the growth of risk-averse sentiments (threat of US default) and the increase of hawkish expectations (likelihood of a rate hike at the June meeting). On Friday, dollar bulls essentially lost one - and quite an important one under the circumstances. After all, as soon as US politicians resolve the issue of raising the US debt limit (which I personally don't doubt), the market will, first, see increased interest in risk, and second, "classic" fundamental factors will come to the fore, many of which are not on the greenback's side.

Therefore, Powell's Friday speech will still play its role in the fate of EUR/USD - but only when the negotiating saga in Washington finally ends with a traditional happy ending.