Dollar Falls Most in 7 Years as Fed Shock Spills Into Second Day

Deep Dive Into Fed Policy and U.S. Economy
  • Central bank's stance bolsters higher-yielding currencies
  • Investors start to question future of dollar's rally

The dollar reached its largest two-day decline since 2009 on Thursday as investors recalculated the Federal Reserve’s tightening path after the central bank cut forecasts for economic growth and inflation, and set a higher bar for when it may raise rates again.

The greenback fell against all of its 16 major peers in New York after Fed officials lowered their projections for rate hikes to two this year, and stressed their commitment to reaching their 2 percent inflation target, saying they need “actual and expected progress” on prices to keep pushing rates up. The yen’s strength against the dollar had fueled speculation that the Bank of Japan was checking exchange rates with banks, a move that some traders see as a prelude to possible intervention.

"The Fed squeezed out a whole layer of dollar longs, and people are very unwilling to pile back into it," said Greg Anderson, global head of foreign-exchange strategy in New York at Bank of Montreal. "The people from other asset classes who were drawn into the long-dollar trade -- the attraction for them is not there anymore." A long position is a bet that an asset will increase in value.

The Fed meeting prompted investors to question whether the dollar’s rally has run out of steam. Until this year, the U.S. currency had outperformed most developed and emerging-market currencies as the promise of superior economic growth and rising interest rates contrasts with sluggish economic activities elsewhere. Investors are questioning whether the U.S. can escape the storm of a global slowdown unscathed and continue with a second, or even more, hikes in 2016.

The Bloomberg Dollar Spot Index, which tracks the currency against 10 major peers, was little changed at 1,182.93 as of 8:11 a.m. in Tokyo Friday, after sliding 1.1 percent in New York and reaching its biggest two-day decline since March 2009. The greenback was at 111.38 yen from 111.39 Thursday, when it lost 1 percent. The dollar’s loss was the most pronounced against emerging-market currencies Thursday, led by advances of more than 3 percent for South Africa’s rand and Brazil’s real.

“Putting a little bit more of a dovish tone into the whole statement would suggest that you’d have a much more slower gradual increase, which would suggest a weaker dollar,” said Fabian Eliasson, head of U.S. corporate foreign-exchange sales in New York at Mizuho Financial Group Inc. ‘It caught some people by surprise.”

The dollar index has weakened more than 4 percent this year, paring a 9 percent gain in 2015 and an 11 percent rally the year before.

The yen briefly pared its advance versus the dollar just after 8 a.m. in New York before resuming gains. The sudden move spurred speculations that Japan’s central bank made “rate check” calls to some banks with implicit questions on whether they planned to buy more yen.

A climb to 105 per dollar is likely to prompt Japanese officials to intervene verbally to try and talk it down, while gains past 100 could spur sales of the yen to weaken it, said Eisuke Sakakibara, the former Finance Ministry official dubbed "Mr. Yen" for his role overseeing currency intervention in the 1990s.

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