Dollar Traders Now Looking for 5.25% Rates (page 1 of 2)

US Dollar

The US Federal Reserve raised interest rates for the fifteenth time by a quarter of a point today to 4.75 percent, the highest level in 5 years. The FOMC statement was also much more bullish than the market was expecting.

With Fed Fund futures originally showing only a small minority favoring 5.25 percent rates, the positive outlook on growth and concerns for rising inflation pressures has 5.25 percent the more likely top now. Newly installed Fed Chairman Ben Bernanke made his mark at today's meeting by changing the entire middle paragraph, or the meat of the statement.

The committee now believes that the weaker numbers that we saw in the fourth quarter of last year were due to temporary or special factors. We will be fascinated to hear what these "special factors" are since most of the talk of the slowdown was due to higher interest rates crimping the housing market or energy prices.

The Fed sees current growth as strong but expects it to moderate to a more sustainable pace. However in contrast to Greenspan's more concise comments on inflation, in true Bernanke style, the updated comments on inflation were far clearer.

The Fed said that even though the "run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures."

The bottom-line is that the dollar is rallying on the more hawkish comments, especially since they reiterated that "further policy firming may be needed." This suggests that we are in store for two more rate hikes. However with a great deal of economic data still due for release this week and five central bankers scheduled to speak, we expect a lot more volatility in the days to come. A vertical rally in the dollar here on forward is far from certain.

Euro

To the surprise of the market, the German IFO survey jumped from an upwardly revised 103.4 to 105.4 for the month of March. The Euro screamed higher on the back of the release, confirming that the stronger number caught the market entirely off guard. Of course the Euro lost most of its momentum going into and on the back of the US interest rate hike.

The long stretch of stronger business confidence in Germany has continued for yet another month indicating that even though analysts or the so called "experts" are becoming more pessimistic about the economic outlook, businesses are not. In fact, business confidence is now at a 15 year high. The worry of analysts was that higher interest rates around the world would hurt growth and eventually also negatively impact German exports.

However, businesses may not be thinking as far forward and are instead basking in the benefits of a weak Euro. It certainly doesn't hurt that inflation is also stronger with M3 rising from 7.6 percent to a higher than expected 8.0 percent in February. Booming confidence and signs of inflation pressures provides more confirmation for the ECB to raise interest again in May.

Central bank President Trichet was on the wires this morning reiterating his view that interest rates remain at very low levels. Meanwhile, as expected, the FX market has made little mention of the strike in France that began today.