The U.S. dollar index fell on Wednesday, closing down 0.44% at 102.09. The U.S. dollar index weakened as Federal Reserve Chairman Powell’s previous remarks about the ongoing fight against inflation failed to meet more hawkish market expectations.

Federal Reserve Chairman Jerome Powell confirmed in his speech on Wednesday morning that further interest rate increases are likely in the future as inflation is “much higher” than it should be. He said: “Inflation pressures continue to rise, and there is still a long way to go to reduce inflation to 2%.” Powell said that although there are signs that labor market conditions are easing, they remain tight. A week after Federal Open Market Committee (FOMC) officials decided not to raise interest rates for the first time in more than a year, the central bank leader said the move may be a brief respite rather than a sign that the Fed is done raising rates. “Nearly all FOMC members expect that further interest rate increases will be appropriate before the end of the year,” Powell said.

After last week’s two-day FOMC meeting, officials said they expected a total of 50 basis points of rate hikes by the end of the year. This would mean two more rate hikes, assuming a 25 basis point hike. The Fed’s benchmark borrowing rate is currently fixed at a range of 5%-5.25%.

Powell said the central bank still has more work to do. “Inflation has moderated somewhat since the middle of last year. Still, inflationary pressures remain high and there is a long way to go to get inflation down to 2%,” he said. Fed officials generally prefer to focus on the “core” Inflation, a measure that excludes food and energy prices. According to the central bank’s preferred PCE indicator, the inflation rate as of April was 4.7% year-on-year. Core CPI in May was 5.3%. Monetary policy initiatives such as interest rate hikes and the Fed’s efforts to reduce the amount of bonds on its balance sheet tend to take effect with a lag. As a result, officials decided not to raise rates at this month’s meeting as they observed the impact that tightening policy has had on the economy.

Powell said the labor market remains tight, although there are signs that conditions are easing, such as an increase in labor force participation in the 25- to 54-year-old age group and a moderation in wages. But he noted that the number of open positions still far outstrips the available workforce. He said: “We are already seeing the impact of policy tightening on demand in various parts of the economy that are most sensitive to interest rates. However, the full effect of monetary restrictions, especially on inflation, will take time to unfold.” Powell later said the Fed has adjusted its policy approach after raising interest rates at the most aggressive pace since the early 1980s. That includes four consecutive 75-basis-point rate hikes, a pace Powell said now looks inappropriate.

But Powell also pointed out that to reduce inflation, the economy needs to slow down to below-trend growth. He also stressed that interest rate decisions would be made meeting after meeting based on the data received, rather than following a preset line. His speech also briefly mentioned the banking turmoil earlier this year. Powell said the incident was a reminder that the Fed needs to ensure its oversight and regulatory measures are appropriate.

Karl Schamotta, chief market strategist at commercial payments company Corpay, said: “It looks like Powell has failed to be more hawkish than the market expected, and the market had expected him to more clearly emphasize the median forecast in the latest economic forecast dot plot.” He “By sticking to the balanced, data-driven rhetoric of last week’s press conference, he’s prompting investors to bet that continued deceleration in growth and inflation will mean one — not two — rate hikes by the end of the year.” Investors widely expect the Fed to resume raising interest rates at its July meeting, but financial market indicators reflect skepticism that the Fed will raise rates further after the July meeting. 

In its mid-year assessment of currency markets, Italy’s UniCredit Bank said the dollar looked set to hit headwinds over the summer. This assessment shows that EUR/USD will break through 1.10 in 2024. The Italy-based bank’s analysis shows the dollar is destined to enter a longer-term period of decline, but markets will have to wait for the Federal Reserve to start cutting interest rates. Roberto Mialich, currency strategist at the bank in Milan, said: “We expect the Fed to raise interest rates again in July to 5.50% and keep it unchanged for the rest of the year. The Fed’s easing policy will only start in the first quarter of next year.” The remaining interest rate hikes by the Federal Reserve can provide some support for the US dollar, but analyst Mialich believes this will restrain the strength of the euro against the US dollar. Therefore, the bank’s year-end forecast for the currency pair is 1.12, but it believes that the potential for the currency pair to rise above 1.10 is still quite limited. Meanwhile, the bank’s economists expect the European Central Bank to raise interest rates to 4.00% by September, which would keep EUR/USD above 1.05 for the rest of the year, according to Mialich.

We will also need to pay attention to the Federal Reserve’s economic data and changes in market expectations on whether the Federal Reserve will raise interest rates at its July meeting.