USD crashes as Fed surprises markets with dovish forecast for 2024

Yesterday, 13^th December 2023, the Federal Reserve’s FOMC held their last meeting of the year. Their decision to keep rates on hold was already priced in, but the big surprise was the dovish forecast for 2024, with at least three rate cuts now expected by the committee over the course of next year.

Last week I talked about the worrying divergence between market expectations and central bank signalling. With this forecast, we are now beginning to see market hopes and Fed policy align. A welcome relief for investors and market analysts.    

The market-friendly tone continued in the accompanying statement and comments given by Jay Powell, Chairman of the Federal Reserve, in the aftermath of the rate decision. “We are very focused on not making the mistake of keeping rates too high too long”, he said. He later added the Fed would not wait until inflation had returned to 2 per cent to begin to cut rates because “you want to be reducing restriction on the economy well before, so you don’t overshoot”.

“They went from higher for longer in September to talking about rate cuts [in December],” said Priya Misra, a portfolio manager at JPMorgan Asset Management. “They were behind the curve on inflation, but maybe they want to be ahead of the curve in terms of a slowdown.”

Markets responded immediately, with the USD, as represented by the DXY index, falling 0.9% and the EUR/USD breaching the psychologically important 1.0900 level overnight. The S&P 500 gained 1.4% to close at its highest level since January 2022 and the benchmark 10-year Treasury yield fell 0.17%.

European stock markets continued the rally this morning. The Stoxx Europe 600 rose 1.5%, France’s CAC 40 added 1.5 per cent, and London’s FTSE 100 gained 1.7 per cent.

Forex traders will now turn their attention to Europe, where the Bank of England (BOE) and the European Central Bank (ECB) are both expecting to leave interest rates unchanged today. However, traders will be closely examining the accompanying statements and post-decision statements.

The US has made it clear that rates are going to come down in 2024. Any hint that the UK and the Eurozone will bring down rates any slower will turbocharge the EUR/USD rally and put more pressure on the USD. However, any rally will be tempered by the more fragile economic state both the EU and the UK find themselves in.

In amongst all the market exuberance, some analysts are wary. The fear remains that looser financial conditions will lead to a resurgence in borrowing and spending, further hampering the fight against inflation.

Vincent Reinhart, who worked at the Fed for more than 20 years, said, “Investors are like the kids in the back seat saying, ‘are we there yet’ and they are just going to keep saying [that] at every meeting and their pricing will make the journey longer.”

Technical Analysis

After a week of hovering near the 1.0760 support (and the corresponding 38.2% Fibonacci retracement level of the July – September 2023 downtrend), Tuesday saw the EUR/USD jump above the 50 EMA (pink) and rise almost 100 pips following Wednesday’s FOMC announcement, soaring past the 200-day MA (orange).  

Having passed the important 1.0900 psychological handle, and with the uptrend showing no signs of slowing, according to the RSI (at 61,8), the next major resistance level to look out for is 1.0960, the 61.8% Fib retracement level.

On the other hand, if the uptrend is exhausted, a turn-around would see traders eyeing the 1.0830 support, and below that, the 1.0765 level.

EUR/USD Daily Chart by XTB, prepared by Alison Heyerdahl