US dollar falls as on-hold Fed casts doubt over pace of rate hikes

[NEW YORK] The US dollar fell after the Federal Reserve left its key interest-rate target unchanged and emphasised a gradual path toward tighter monetary policy, dimming the outlook for increases through the end of next year.

The greenback weakened against most of its major peers after officials scaled back their expectations for rate hikes in 2017 and over the longer term. The Fed's "dot plot", which it uses to signal its outlook for the path of interest rates, shows that policy makers expect one quarter-point rate increase this year, followed by just two next year. Emerging-market currencies strengthened along with the yen.

"The longer view is that the US dollar won't get the expected support of higher rates - therefore, you're seeing it weakened right now," said Minh Trang, a senior foreign-exchange trader at Silicon Valley Bank in Santa Clara, California.

The announcement further dims the outlook for the US dollar after a 20 per cent surge since the middle of 2014 gave way to a 4 per cent slide this year in the run-up to the decision.

Currency traders are losing faith in the prospects of continued monetary policy divergence with central banks in Europe and Japan, questioning the resolve of Fed policy makers to raise interest rates after months of inaction.

The Bloomberg US dollar Spot Index fell 0.7 per cent as of 5pm in New York, after touching the strongest level since July 29. The greenback lost 0.3 per cent to US$1.1189 per euro and weakened 1.4 per cent to 100.32 yen.

"The US dollar is going to suffer," said Win Thin, global head of emerging markets at Brown Brothers Harriman & Co in New York. "To me, it's dovish."

The Fed decision comes after the Bank of Japan announced a more flexible approach to expanding stimulus Wednesday, while seeking to control bond yields across different maturities. The yen rose to the strongest level since Aug 25 after the initial slide.

An index of 20 emerging-market currencies rose 0.7 per cent, reaching the highest level since Sept 8.

"There's a little bit of disappointment," said Jeremy Cook, chief economist and head of currency strategy at London-based World First UK Ltd. "They could have been a bit more hawkish - 25 basis points is not going to change the world. There's a lot of road to travel between now and December."

Regardless of when the Fed moves next, US dollar bulls face the prospect of the slowest and shallowest tightening cycle in recent history, based on the market for overnight index swaps, which reflect expectations for the fed funds effective rate.

The contracts imply the rate will rise to about 0.9 per cent in three years from 0.38 per cent now - essentially just two hikes during the next 36 months.

Still, the outlook for a rate hike by year end looks likely. Three officials, the most since December 2014, dissented Wednesday in favour of a quarter-point hike.

Esther George, president of the Kansas City Fed, voted against the decision for a second straight meeting. She was joined by Cleveland Fed President Loretta Mester - in her first dissent - and Eric Rosengren, head of the Boston Fed, whose previous dissents called for easier policy.

Hedge funds and other speculators are among those with the most at risk. They've been betting on US dollar gains since May, and those wagers now tally about US$8 billion.

Bets that the US dollar would rise outnumbered bearish positions by 113,195 contracts in the week ended Sept 13, according to data from the Commodity Futures Trading Commission.

BLOOMBERG