After last week’s much-anticipated FOMC meeting struck a surprisingly more dovish tone than markets had expected, Fed officials have since been signalling that the decision to keep rates unchanged was a close call and a rate hike later this year remains a likelihood.
The dollar index, which measures the value of the dollar against a basket of major currencies, fell to a 3½-week low following the FOMC statement last Thursday. The statement cited the downward pressure on inflation in the near term from the recent global economic and financial developments as the main reason for keeping the target range for the Fed funds rate at 0%-0.25%. In the press conference that followed the FOMC decision, Yellen spoke of a “tightening of financial conditions”.
But the outlook on employment was much more positive with strong jobs growth and diminishing underutilization of labor resources. This is worrying the Fed hawks who see it as only a matter of time until the strong jobs market translates to higher wage growth, which would push up inflation.
In what has turned out to be conflicting language from the Fed, several policymakers have since strongly hinted at the possibility of interest rates going up later this year. Richmond Fed President Jeffrey Lacker, who was the only dissent within the FOMC’s 10 voting members, wrote in a statement published on the Richmond Fed’s website that “further delay would be a departure from a pattern of behaviour that has served us well in the past”.
On Saturday, two Fed officials, John Williams and James Bullard, also sounded quite hawkish. Williams said he views an interest rate rise “most likely starting sometime later this year”. Bullard, who is not a voting member, said that he would have voted against the Fed’s decision to keep rates unchanged, stressing that even with a 0.25% increase, rates would remain accommodative.
Their views were supported by Atlanta Fed President Dennis Lockhart, who at a speech in Atlanta on Monday, said that the decision was a “close call”. He described the decision to keep rates on hold as “prudent risk management around recent and current market volatility” and he remains confident that rates will go up later this year.
The dollar bounced back following the upbeat remarks, recovering all of its losses from the FOMC meeting, although it’s been struggling to rise much past above the 120 handle against the yen as some risk aversion still remains. The euro meanwhile is being weighed down by the prospects of further monetary easing by the European Central Bank. ECB officials have been quite vocal recently on the central bank’s commitment to using whatever tools available within its mandate to ensure that inflation returns close to the 2% target.
The divergence in policy between the Fed and the ECB is likely to continue until at least into the second half of 2016, maintaining the downward pressure on the euro. The Bank of Japan, which is also still engaging in quantitative easing, has been more cautious about the possibility of expanding its current program, providing some support to the yen. A clearer sign on future Fed policy may come on Thursday when Fed Chair Janet Yellen is due to speak at the University of Massachusetts.