The U.S. Federal Reserve increased the interest rate by 25 basis points following the May meeting, fully meeting market expectations. On the eve of the announcement of the May meeting's results, the probability of such a scenario was over 90% (according to the CME FedWatch Tool data). Therefore, traders' primary focus was on the text of the accompanying statement and Jerome Powell's rhetoric, which disappointed dollar bulls.
Out of all possible options, the Federal Reserve chose the most "dovish" one, putting pressure on the greenback. As a result, buyers of the EUR/USD pair approached the 11th figure closely (yesterday's high was recorded at 1.1100) but did not decide to assault this price level. The soft wording of the accompanying statement was still expected by the market. Suppose the Fed had maintained a hawkish stance. In that case, the surprise effect would have provided significant support to the dollar, while the stated theses clearly echoed traders' expectations, so they did not produce the desired effect. Additionally, there was the restraining "ECB factor," which did not allow the EUR/USD bulls to consolidate above the 1.1100 target.
The devil is in the details
After the March banking collapse, the market began to talk about the regulator being forced to pause the rate hike, as the emerging banking crisis is one of the side effects of the Fed's aggressive monetary policy. Some hot heads assumed that the Federal Reserve would even lower the rate, reacting to resonant events. The situation was complicated by the fact that the SVB collapse occurred a few days before the March meeting when the so-called "quiet mode" was in effect (central bank representatives are not allowed to voice comments in the public domain within 10 days before the meeting). However, contrary to dovish expectations, the Federal Reserve not only raised the rate by 25 basis points but also did not rule out further steps in this direction. This result provided temporary support to the greenback, which strengthened against the euro to the base of the 7th figure.
A similar situation arose on the eve of the May meeting. A few days before the hour X, U.S. regulators closed the First Republic Bank, selling most of its assets and deposits to JPMorgan. The bankruptcy of FR became the third-largest collapse in the U.S. financial system since the 2008 financial crisis.
That is why many experts did not expect a "hawkish surge" from the Fed members, despite the growth of the core consumer price index and inflation components of the U.S. GDP growth report.
In this regard, their expectations were met: the Federal Reserve did not tighten its rhetoric, stating that in determining further monetary policy prospects, it would take into account the cumulative volume of monetary policy tightening and the lagging effects of monetary and credit policy, "as well as inflation, economic, and financial development."
This thesis is vague and quite general, allowing for different interpretations of the Fed's stance: on the one hand, the regulator does not put an end to it; on the other hand, it makes it clear that there is no predetermined trajectory for raising the rate.
And yet, the May meeting did not pass without surprises. The regulator removed from the accompanying statement's text a key phrase about the need for further tightening. For example, the final communique of the March meeting stated that the Fed expects further tightening of policy necessary to achieve a sufficiently restrictive course. Following the May meeting, the FOMC members replaced this phrase, stating that when discussing the prospects for further monetary policy tightening, "the tightening already carried out to date, the lag of the policy, and other events will be taken into account."
A pause with an additional option
Formally, the American regulator maintained its hawkish course, stating that the assessment of the need for a more stringent policy "will be conducted constantly, from meeting to meeting." According to Jerome Powell, it is currently impossible to say with certainty whether the central bank has reached a sufficiently restrictive level, so the FOMC members "will return to this issue at the June meeting." He also noted that subsequent decisions would largely depend on incoming data, primarily in the field of inflation.
That is, on the one hand, Powell left the door open for further steps towards tightening monetary policy (while emphasizing that he does not foresee a rate cut this year).
On the other hand, the regulator clarified that it would only use this "option" in case of extreme need—obviously, if core inflation continues to accelerate. The exclusion of the key phrase from the accompanying statement indicates that the base scenario for the Fed is to maintain a wait-and-see position, at least in the context of the June meeting. This is also evidenced by the data from the CME FedWatch Tool. The probability of a 25-point rate hike at the June meeting is currently 2%. Accordingly, the probability of maintaining the status quo is 98%.
Conclusions
The U.S. Federal Reserve put pressure on the U.S. currency following the May meeting. It is highly likely that yesterday's rate hike was the "final chord" of the current monetary policy tightening cycle.
Nevertheless, despite the weakening of the greenback, EUR/USD buyers failed to impulsively conquer the 11th figure. Therefore, at the moment, it is advisable to maintain a wait-and-see position on the pair: the market is awaiting the ECB's verdict and subsequent comments from the Central Bank head Christine Lagarde. Therefore, the fundamental puzzle will only be completed by Friday when market participants crystallize their overall opinion on the outcomes of the May meetings of the Fed and the ECB.