Financial markets got what they expected from the Fed, the tenth consecutive rate increase in as many FOMC meetings. The Fed has raised rates by 500 basis points (5%) since the cycle began in March 2022. The dollar was slightly weaker in immediate reaction to the announcement.

Chairman Powell said the support for the rate increase was "very strong" and the committee's vote was unanimous. In cautiously worded answers to questions raised in the post-announcement press conference, Powell is "prepared to do more" to bring inflation down, if necessary. Powell said Fed officials believe inflation won't come down quickly, adding, "In that world…it would not be appropriate to cut rates."

‍The dollar, already near its recent low, continued to weaken against most major currencies. The euro remained above 1.10, and the pound held above 1.25. The dollar/yen pair closed just below 135. The Mexican peso hit a new high for the year, strengthening against the greenback.

‍What's next for the dollar: Analysts have mixed views on the dollar's movement for the rest of the year. Most expect the recent downtrend to continue as the dollar drops from the multi-decade highs established in September 2022. 

• The European Central Bank (ECB) followed the Fed and raised its base rate by 25 basis points less than 24 hours after the Fed's action. ECB President Christine Lagarde said, "We are not pausing—that is very clear. We know that we have more ground to cover." Expectations for steady rate rises in Europe will likely keep the euro on track for more gains against the dollar.
• Interest rate futures markets show that most investors expect no further increases in US interest rates. Despite Chairman Powell's statement that he does not see rates coming down this year, the CME Fed Watch tool points to expectations for rate decreases starting in late summer. A rate drop would narrow the dollar's interest rate advantage, contributing to its weakness over time.
• Latin American currencies are expected to remain strong against the dollar as Brazil and Mexico maintain double-digit interest rates (13.75% for Brazil and 11.25% for Mexico).
• The dollar index (DXY) closed at 101.22 on Wednesday, fractionally above the year's low of 100.79. Technicians call for additional weakness with a short-term target of 98-99. That would erase all the gains realized since the Fed started raising interest rates in March 2022.
  

In the coming weeks, markets will pay close attention to US economic and political developments. There is ongoing concern about the health of the US banking system and the potential for credit contraction and a decrease in business lending. There are also fears of the US failing to raise the debt ceiling. On Tuesday, Treasury Secretary Janet Yellen said the US could default as soon as June 1 if no resolution is reached. A default would throw global financial markets into disarray with potentially negative effects on the price of the dollar.

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Takeaways:

• The reaction to the Fed's latest action was muted, mainly because the market had expected and priced in the 25 basis point increase. Investors will pay close attention to upcoming economic data for indications of changes in US inflation and job growth.
• Narrowing interest rate differentials will likely contribute to the dollar's current weakness.
• Recent market action has shown that the dollar has lost some of its status as a "safe haven," so global turmoil may not bring traditional flows into the greenback.
• Most of the world's economies would benefit from a weaker dollar, so central banks are unlikely to pursue policies that would result in a move higher.

Currency markets are notoriously unpredictable. Though most analysts are bearish on the dollar, new factors may emerge that could boost the dollar in global Forex markets. "Sticky" inflation prompting the Fed to raise interest rates would upend the current forecasts, as would new data indicating strength in the US economy.

Risk managers should be prepared for any eventuality. Forex volatility will likely rise from current low levels, so companies should assess their risks and take appropriate measures to protect themselves from adverse movement.

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