The dollar leapt to nine-month highs on Friday after the US Federal Reserve took a big step towards unwinding its massive economic stimulus programme.
Markets were caught off guard by the Fed’s announcement late on Thursday that it had raised its discount rate – the level at which commercial banks tap the central bank for emergency funding.
While the move had been well-flagged, its timing was a surprise and refocused investors on worries about how economies and companies will cope as central banks start to withdraw support for credit markets and tighten monetary policy, leading to higher interest rates.
In a sign of the Fed’s increasing confidence in the strength of the US economic recovery, the discount rate was raised by a quarter of a percentage point to 0.75 per cent – above the benchmark Fed funds rate.
The dollar spiked higher against the euro and sterling, with the euro losing more than a cent in just minutes – which is extremely rare – to a low of $1.3442. It later rebounded to $1.3588. The pound suffered after a drop in retail sales raised fears of the economy contracting.
Although the Fed made clear that it did not intend the move as the start of a rate-rise cycle by stealth, analysts said it would still influence markets.
Ulrich Leuchtmann, head of FX research at Commerzbank, said: “It no longer matters whether the Fed funds rate will be raised in August, September or November. What matters is that the Fed is the only large central bank able to raise rates in the foreseeable future.”
Since December, the dollar has been rising against a range of currencies, helped by investors unwinding “carry” trades, where they borrowed cheaply in dollars and invested the proceeds in higher-yielding assets.
Expectations for a stronger economic recovery in the US have raised expectations for interest-rate rises there, perhaps later this year, making the carry trade less profitable.
However, the Fed will have to be careful that the market does not read too much into Thursday’s move, warned analysts.
Marc Chandler, head of currency strategy at Brown Brothers Harriman, said: “While the Fed is probably not concerned about the short term reaction and likely anticipated the market’s reaction, the central bank will want to prevent the market from tightening for it.”