Greenback continues to gain more ground thanks to a “welcomed” mix of geopolitical instability and increasing policy lag between the Fed and other major central banks. Even though the market positioned itself for a “worst-case” meeting scenario, the Fed managed to surprise even hawks with its updated dot plot projections. They indicated sharp revisions in expected rate hikes in short- and medium-term. Those hoping to sell the dollar at the event tried to use the remark made by Powell at the press conference that the policy setting will continue in a meeting-by-meeting fashion, but quickly became disillusioned when the Fed chief said that the last two meetings of this year would see rates rise another 100 or 125 basis points. Dot plot showed that the Fed may deliver an additional rate hike next year which smashed expectations of a possible “Fed pivot”. The terminal rate implied by the market thus added another 15 basis points and is estimated at 4.65%.
By tightening the monetary policy and recognizing that it could lead to a recession, the Fed finds itself in a situation that is reminiscent of the one it faced in the 1980s when Paul Volcker was at the head of the Fed. His ultra-aggressive Fed tightening led to a recession during which short-term bond interest rates were significantly higher than long-term ones, i.e., there was an inversion of the yield curve, and the dollar index soared to 160 points (now 110). Now that some momentum has appeared in the uptrend of the dollar, significant resistance should probably be expected at the level of 120 on the DXY. If the price reaches this mark, the EURUSD will be at the level of 0.92, and the USDJPY will rise to 155 points.
However, in the short term, the fall of the yen will be held back by the psychological effect of Japan's foreign exchange intervention, which plunged the USDJPY by 2.5% on Thursday. The government has made it clear that the market has reached its temporary "tolerance limit" at 145 yen per dollar. At the same time, the Bank of Japan maintained its stimulus policy following Thursday's meeting, which means that the interest rate differential will continue to put downward pressure on the exchange rate.
Today, several other central banks made decisions and among them the Bank of England. The regulator kept the rate at the same level (2.25%) by unanimous decision. The interest rate differential factor will therefore continue to put pressure on the GBPUSD, so the downtrend is far from over in my opinion.
The search for yield, however, is a less significant factor for the EURUSD, as the ECB is still set to further tighten policy. The depreciation is due to the growing risks of geopolitical tensions and the energy crisis, which may sparkle with new colors after another round of escalation in a proxy conflict with the Russian Federation. The transition of the EU trade balance from surplus to deficit is also a bearish factor for the Euro (foreign exchange demand is growing from imports, supply from exports declines), the impact of which is expected to only intensify by winter. From the point of view of technical analysis, the level of 0.95-96 appears to be an attractive target for bears in the short term: