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Dollar at 14-month low after Fed backs dovish market mood

The dollar slid to a 14-month low and Wall Street stocks hit new highs after a dovish tone from the Federal Reserve allowed investors to push back rate-rise bets and extend the recent risk-taking mood.

Markets brushed aside the Fed’s signal that it would begin shrinking its balance sheet as soon as its next meeting in September — essentially another form of monetary tightening — and chose to dwell instead on the Fed’s tacit acknowledgment that inflation remained softer than it had expected.

“Nothing in this statement changes Pimco’s view that a third rate hike this year is far from a done deal,” said Richard Clarida, global strategic adviser at the California-based fund manager. “If there is no rebound in core inflation between now and December, the next rate hike may be a decision for the next Fed chair, if Janet Yellen is not reappointed.”

Currency markets were the most affected, with the euro powering through $1.17 to hit a 30-month high at $1.1747, up a full cent against the dollar from its level ahead of the Fed meeting. The yen also gained against the US currency, pushing it from Y112.1 in New York to Y110.9 in Asian morning trade.

The dollar index, which measures the currency against a trade-weighted basket of its peers, dropped 0.7 per cent to 93.359, its lowest since May last year.

Global markets were caught off-guard last month by a series of hawkish comments from central banks including the European Central Bank, the Bank of England and the Bank of Canada. But in recent weeks softer data and a more dovish tone from those banks and others have weakened the notion that global monetary tightening is imminent.

The Federal Reserve’s contribution on Wednesday was simply to remove the word “somewhat” from its line on inflation at its last meeting to say this time that price pressures were “running below 2 per cent”.

But it was enough to move markets.

“The Fed statement didn’t break unexpected ground, but by not being hawkish [it] validated the recent dovish shift in expectations of a flatter [rate] hiking trajectory,” said Johanna Chua, chief Asia economist at Citigroup. She added that the statement’s tone reduced the risks, in traders’ eyes, that the Fed could suddenly turn hawkish in the coming months.

Bonds rallied, pushing yields on benchmark 10-year notes down 6 basis points on the news to 2.277 per cent in Asian trade. On Wall Street the S&P 500, the Nasdaq Composite and the Dow Jones Industrial Average all edged up to set record closing highs.

Futures contracts now imply just a 4 per cent chance of an interest rate rise in September — down from a 50 per cent probability in May. December contracts suggested a 40 per cent chance of a rate rise by year end, down from 60 per cent two months ago.

“Some of the slippage in inflation is due to temporary factors, but it will be hard for the Fed to push through a sequence of rate hikes in 2018 unless inflation is heading towards its 2 per cent target,” said Richard Jerram, chief economist at Bank of Singapore.

The Fed kept rates unchanged at 1 per cent to 1.25 per cent at the meeting — as expected. But in a sign of resolve on its policy committee, the US central bank said in a statement that it was ready to start paring back the size of its balance sheet “relatively soon” as long as the economy stays on track.

Ms Yellen has spent the year preparing the ground for the landmark moment when the Fed puts its quantitative easing programme into reverse. The Fed scooped up trillions of dollars of Treasuries and mortgage-backed securities during the crisis and has been reinvesting the proceeds of securities as they mature, maintaining its balance sheet at about $4.5tn.

With financial markets rocketing to new highs and unemployment hovering at just 4.4 per cent, the central bank is set upon gradually withdrawing that stimulus in a predictable manner that it hopes will avoid roiling the markets.