In lowering its likely path of future interest rate increases this week, the Federal Reserve pushed down the dollar, perhaps aiming to ease strains caused by clashing monetary policies.
Economists and investors alike were surprised when the US central bank announced Wednesday that it only sees two rate hikes in 2016, half the number it envisioned in December, a more accommodative stance in exiting crisis-era policy.

The Fed also left its benchmark federal funds rate at a historically low 0.25-0.50 percent, as expected, after raising it in December for the first time in nine years.

The policy-setting Federal Open Market Committee "backed off on the number of expected rate hikes this year. Why, I really don't know," said Joel Naroff of Naroff Economic Advisors.

"If you look at the recent data, and the members are supposed to be data-dependent, it is clear that whatever economic issues concern them, it cannot be US economic weakness."

While spotlighting its more optimistic view on the US economy, the Fed also broadly cited "risks" from the global economic slowdown and financial market turmoil.

Several analysts and economists interpreted the language as an effort by the Fed to rein in the dollar's gains against other currencies. A strong dollar weighs on import prices, thus keeping US inflation in check, and encourages volatility on the financial markets.

Interest rates are on an upward bound in the United States, which attracts investors seeking higher yields and boosts the greenback.

The opposite is true in a number of other central banks, such as in the eurozone and Japan, where authorities are redoubling their efforts to be more accommodative and revive their sluggish economies.

The stark divergence in monetary policies -- between negative rates on one side and the potential for hikes on the other -- had underpinned the attractiveness of the greenback all through 2015.

The dollar, which gained nearly 10 percent last year against a basket of currencies, has fallen about three percent since early March.

- Dollar key to Fed puzzle -

For the economists at Barclays Research, "the Fed has become increasingly responsive to changes in financial conditions" and too much of that could lead to "policy paralysis."

"Although not exclusively a story about the relationship between Fed policy and the foreign exchange value of the dollar... we believe it clearly illustrates the conundrum," they said in a client note.

Fed Chair Janet Yellen acknowledged the importance of the dollar in policy making at her post-FOMC meeting news conference Wednesday.

"Movements in exchange rates... are a factor that any country needs to take into account in deciding what is the appropriate stance of monetary policy," Yellen said.

But, questioned about influence from the divergence in monetary policies, she insisted: "It does not mean that monetary, US monetary policy is somehow constrained in a way that makes it impossible for our monetary policy to diverge from policies abroad."

Kit Juckes, a foreign-exchange analyst at Societe Generale, said the Fed "seems committed to driving inflation expectations higher, and in the process, is doing nothing to support the dollar."

The Fed's more dovish tone "stymied the policy divergence trade" of investors, noted Patrick O'Hare at Briefing.com.

Some even say it goes farther than that, seeing in the Fed's more cautious attitude as part of a concerted strategy by the Group of 20 major economies to tamp down the dollar.

"To any conspiracy theorists it's all become quite clear. There is a global coordinated central bank effort to weaken the (dollar) in play," said Chris Weston, chief market strategist at IG Markets, evoking a secret "Shanghai Accord"at the G20 meeting of finance chiefs last month.

Julian Jessop of Capital Economics also highlighted the issue: "Is the G20 trying to steer the dollar lower?"

He suggested, however, that the Fed's dovishness could "soon evaporate" if inflation pressures keep building, forcing it to raise rates and watch the dollar grow stronger.
SourcE: AFP