3 Reasons Why the FOMC Statement Led to a Dollar Selloff

Out of the five central bank events this week, the FOMC rate decision had the biggest potential of moving the markets and it did not disappoint. Unfortunately for dollar bulls though, the Fed’s announcements triggered a selloff for the U.S. currency and here’s why:

1. Downgraded growth forecasts

As expected, the Fed acknowledged the recent improvements in the U.S. economy and decided to carry on with its $10 billion monthly reduction in bond purchases. Policymakers even came up with more optimistic estimates for employment and inflation this year, as they predicted that unemployment could fall to as low as 6.0% and that annual CPI could reach 1.7%.

What took most market participants by surprise was the lowered GDP forecast for 2014. From their previous estimate of 2.8%-3% annual economic growth a month ago, they slashed their forecast to just 2.1%-2.3%. Talk about giving mixed signals!

2. No tightening timeline

When pressed for a timeline on when the Fed might start tightening monetary policy, Fed Chairperson Yellen didn’t seem inclined to drop any hints at all. Not only does this make her much less upbeat compared to her previous self who said that rate hikes might take place “around six months after asset purchases end”, but it also makes her considerably less hawkish than a couple of major central banks.

Instead, Yellen simply emphasized that the Fed is going to carry on with the taper in “measured steps” and that interest rates will stay low for a “considerable time” after purchases end.

3. Return of risk appetite

While fundamentals have been the major driving force for U.S. dollar price action in the past few months, it appears that risk appetite may have had a hand in pushing the lower-yielding currency lower after the latest FOMC statement.

U.S. equities rallied after Yellen announced better employment and inflation prospects, along with the pledge to keep interest rates low for the time being. The S&P 500 index jumped 0.8% to an all-time high of 1,956.99 while the Nasdaq Composite index marked its fourth consecutive daily increase to 4,362.84. This goes to show that U.S. companies and investors took Yellen’s words as a sign that economic support would not be removed even as prospects are likely to improve, making them confident enough to buy up higher-yielding riskier assets in exchange for safe-havens like the U.S. dollar.

Do you think the U.S. dollar selloff was just a knee-jerk reaction to the FOMC though? Share your thoughts in our comment box or cast your votes in our poll below! 

  • Beijin

    Hi Professor:

    I learned forex in your school.

    I trade fundamental, and always read your posts.

    One of the reasons for the dollar selloff is the return of risk appetite: The S&P 500 index jumped 0.8% to an all-time high of 1,956.99.

    We know USDJPY and S&P 500 have a strong correlation (travel more or less together). In fact, I remember you teach it in one of your lessons.

    Why USDJPY sold off when S&P was up?

    One more question:

    When S&P is going up, this is because investor are buying higher-yielding assets in exchange for safe-havens like the U.S. dollar.

    This would mean S&P and USD have a NEGATIVE correlation?

    Thank you in advance!

    • Forex Gump

      Thanks for checking out my blog regularly! Those market correlations don’t always hold, especially when monetary policy changes also come into play.

      In this particular case, USD was weaker across the board when the FOMC statement wasn’t as upbeat as many hoped it to be. The Fed seemed inclined to keep stimulus in place much longer (good for US companies, S&P rally) but bearish for the dollar (longer period of low interest rates).

      This doesn’t necessarily mean that there’s a negative correlation between the two though, as good economic performance can boost both S&P and USD later on. This phenomenon can probably be best explained using the Dollar Smile Theory: http://www.babypips.com/school/undergraduate/sophomore-year/dollar-index/the-dollar-smile-theory.html

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