The dollar posted a marginal fresh 2-month high amid expectations of further short covering.

The Federal Reserve made no policy changes in the statement. FOMC member interest rate forecasts were significantly more hawkish than expected with a median projection of two rate hikes by the end of 2023.

US bond yields moved higher with some hawkish comments from Chair Powell on inflation. Wall Street equities moved lower amid expectations of an earlier move to tighten policy. Global bourses overall edged lower given more fragile risk conditions.

The dollar posted sharp gains following the Fed statement and strengthened to 8-week highs with further gains on Thursday. EUR/USD dipped to 1.2000 and remained on the defensive on Thursday. GBP/USD retreated below 1.4000 on dollar strength, although Sterling overall held firm.

Commodity currencies retreated sharply after the Fed statement. The Australian dollar was protected by a surge in May employment.

The IFO economic institute cut the 2021 German GDP growth forecast to 3.3% from 3.7% due to supply bottlenecks and also increased the inflation forecast to 2.6% before moderation to 1.9% next year. Tight ranges prevailed ahead of Wednesday’s New York open with caution ahead of the Federal Reserve policy statement.

US housing starts increased to an annual rate of 1.57mn for May from 1.52mn, but below consensus forecasts of 1.63mn while building permits slowed to an annual rate of 1.68mn from 1.73mn. Import prices increased 11.3% in the year to May. The dollar held steady into the Fed statement with EUR/USD consolidating around 1.2120.

The Fed held interest rates in the 0.00-0.25% range and made no change to the asset-purchase programme with both decisions unanimous and in line with consensus forecasts. According to the statement, the Fed committee remained committed to securing maximum employment and a sustained period of inflation above 2.0%. There was a more positive assessment of the outlook and 2021 GDP forecast was revised higher to 7.0%, but the overall commentary was relatively dovish.

There was, however, a significant shift in the forecasts of interest rates from committee members. A majority of members now expect the first rate hike in 2023 from 2024 previously and seven shifted further to forecast an increase in 2022. Median projections were for two rate hikes by the end of 2023 which was significantly more hawkish than expected. The dollar strengthened sharply as markets focussed on the revised interest rate forecasts.

Fed Chair Powell stated that inflation could be higher and more persistent than expected. He also noted that many participants believe that the conditions for lift-off will be met earlier than expected and also noted that the US is on a path to a very strong labour market. He did, however, that substantial progress is still a long way off and that policy will remain accommodative even after lift-off. Powell added that it would be extremely premature to discuss lift off at this time, but at the next meeting the Committee will start the process of evaluating progress.

The dollar maintained a stronger tone following Powell’s comments with EUR/USD dipping to just below 1.2000. The US currency continued to benefit from the shift in Fed expectations with the dollar index at 8-week highs on Thursday with EUR/USD just below 1.2000.

Chinese industrial production growth was held to 8.8% in the year to May from 9.8% previously and slightly below consensus forecasts of 9.0% with a more substantial miss for retail sales as annual growth slipped to 12.4% from 17.7%. Investment growth also slowed and unemployment edged higher. The data maintained some reservations over the Chinese growth outlook, although the immediate market impact was limited.

After drifting lower into the European close, USD/JPY found some support below 110.00. Treasury yields moved higher following the Fed statement with the 10-year yield strengthening to around 1.57%. In this environment, the USD/JPY posted sharp gains to highs around 110.65. The dollar held firm ahead on Thursday ahead of the Bank of Japan policy decision on Friday with the US 10-year yield around 1.58%. USD/JPY traded around 110.65 with EUR/JPY around 132.80.

Sterling was able to post limited net gains ahead of Wednesday’s New York open. The higher than expected UK inflation data for May sparked further speculation that the Bank of England could have to adopt a more hawkish bias and move towards an earlier than expected policy tightening.

There were further concerns surrounding trade relations with the EU as Brexit negotiator Frost stated that there had been little headway in talks over Northern Ireland while Prime Minister Johnson warned that additional steps would have to be taken unless there was progress on the protocol.

Following the Fed statement, GBP/USD dipped to lows just below 1.4000 and Sterling was little changed against other major currencies. GBP/USD traded below 1.4000 on Thursday with cautious risk appetite while GBP/EUR rallied to around 1.1660 amid a small shift in Bank of England expectations.

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