Fed Starts Removing Accommodative Measures, US Dollar Surges Across the Board

The Federal Reserve of the United States (Fed) began the process of removing some of its accommodative measures, and the US dollar catches a bid. The central bank raised the IOER and the RRP rates.

The much-awaited Fed meeting and press conference brought volatility back to financial markets. The US dollar surged in response to a hawkish Fed – a Fed that admitted that inflation is a concern and one that started the removal of some of the accommodative measures in place.

For a central bank of the Fed’s importance, the communication process is vital to avoid unnecessary market turmoil. As such, the central bank made it clear that it will be as transparent as it can when it comes to the removal of the monetary stimulus from the markets.

So far, the Fed did not signal the tapering of its asset purchases. But it did signal that the moment is coming closer and, because financial markets are trading in anticipation, they reacted immediately.

Also, the dot plot released at yesterday’s event was much more hawkish than the market anticipated. The dot plot reveals each member’s opinion about future rates, and it revealed two possible rate hikes in 2023. The market expected only one.

Fed Raises IOER and RRP Rates

The Interest On Excess Reserves (IOER) and the overnight Repo and Reverse Repo (RRP) agreements are viewed by many as secondary in importance when it comes to the signals the Fed sends. Even the Fed’s Chair, Jerome Powell, used the same wording at yesterday’s press conference when it talked about raising the interest rate on the two by five basis points.

But the key to financial markets is that the Fed is removing stimulus. One of the first moves the Fed did was to lower the interest rate on the two when the pandemic started. Now that it is beginning to lift the rates, the market took it as a hawkish sign.

Tapering has moved closer, with many voices in the market arguing now for a decision as soon as the upcoming September. If that is the case, we will find out more from the Fed, probably at the upcoming Jackson Hole Symposium in August.

In the meantime, the US dollar is rallying across the board, as the dollar-short positioning into the event was extreme.