While some financial market participants lauded the recent decision by the Federal Reserve to leave monetary policy unchanged as the best decision for financial markets, many other investors have adopted the stance that Central Banks are too timid and understating the risks of the zero-bound. The kneejerk reaction to the latest FOMC decision was downside in the US dollar as traders pared their bets of normalization, in some cases, anticipating that liftoff would not start until the middle of next year. Even stranger yet, one voting member of the FOMC expects interest rates to move into negative territory despite the lone dissenter to the latest meeting taking a more hawkish stance. With all the indecision, financial markets are reacting in volatile form with relationships between instruments breaking down in recent sessions. The last several years were marked unusually strong correlations across asset classes, one that has broken down recently with a mixed set of winners and losers.
The one major winner from all the uncertainty has been the US dollar. Even though faith in the Federal Reserve is likely plumbing all-time lows, confidence in the dollar remains high as evidenced by the sharp bounce in the dollar after the initial slide following the interest rate decision and press conference. In many ways, the recent rally in the dollar reflects a growing chorus of opinion that expects the Federal Reserve to act ahead of other advanced economies when it comes to liftoff and policy normalization. With that in mind, many traders awaited the bloodbath from the latest decision as marking a favorable buying opportunity at a brief discount. The dollar has nearly retraced all losses incurred during the announcement, meaning that traders are raising the probability of policy action in the October meeting or conversely moving into risk-aversion hibernation mode. This last option points to a period of renewed market uncertainty and investors lining up for the “least dirty shirt” trade in the hopes of coming away unscathed from any inbound turmoil.