Fed's policy statement is nod to global currency war

NEW YORK (Bloomberg) - Federal Reserve chairmn Janet Yellen just acknowledged the negative consequences of the US dollar's gains on Wednesday, saying the currency is weighing on exports and inflation as policy makers pared back their outlook for interest-rate increases.

That sent the greenback down by the most in six years and prompted some analysts to suggest the rally will pause following a 14 per cent rise in the last six months.

"They clearly do care about the dollar, and the Fed's important for the dollar trend," said Jens Nordvig, managing director of currency research at Nomura Holdings in New York. "We're going to have a couple of months of consolidation."

The dollar's ascent has been fueled by the Fed's plans to raise borrowing costs this year at a time when central banks are easing across from the euro area to Canada and Australia. Sweden's Riksbank became this week at least the 23rd central bank to drive down its currency this year, lowering its key interest rate outside of its schedule for policy decisions.

The Fed's indication it will raise rates more slowly than it previously predicted sent the Bloomberg Dollar Spot Index down 1.8 per cent Wednesday to 1,194.89, the biggest drop since March 2009. The index, which is weighted against other currencies including the euro and yen, had reached on March 13 the highest since its 2004 start date.

The Fed "can't ignore the stronger dollar's implications for growth," said Alan Ruskin, the global head of Group of 10 foreign exchange at Deutsche Bank AG in New York. "The U.S. dollar's gains have reached the point where they are willing to indirectly protest dollar strength."

Policy makers cut their estimate for the federal funds rate at year-end to 0.625 per cent, down from a forecast of 1.125 per cent in December. The outlook for 2016 fell to 1.875 per cent from 2.5 per cent.

The greenback has something to do with the cuts to those projections. Yellen, who also lowered her assessment of the economy, said the strong dollar has weighed on consumer prices and contributed to weak export growth and low import prices.

"It puts the U.S. dollar increasingly on the radar - now we know the Fed has its eye on it, and the impact on exports and growth," said Matt Derr, a foreign-exchange strategist at Credit Suisse Group in New York. "We are just seeing some consolidation after a very strong U.S. dollar move in recent months."

While Yellen has downplayed the notion of a global currency war, the Fed has stood out for its plans raise rates as other nations devalue their currencies to spur economic growth and fight deflation.

Her remarks Wednesday prompted money-market traders to push out their expectations for an initial rate increase and to lower bets for how quickly borrowing costs will climb after liftoff. Futures contracts show a 40 percent likelihood that the Fed will raise rates by its September meeting, down from a 55 per cent chance seen prior to the Fed's statement.

"What it means for the dollar is interim weakness," said Jennifer Vail, head of fixed-income research in Portland, Oregon at U.S. Bank Wealth Management. "The dollar will climb again."

"You hardly ever hear the Fed comment about currency," said Gary Pzegeo, the Boston-based head of fixed income at Atlantic Trust Group Inc. "I'm not surprised that they're paying attention to it and I'm further not surprised that they're reacting to it because it does have an impact on the inflation outlook and the growth situation."