Fed rate hike increased pressure on the euro
The euro came under noticeable pressure on the global currency market after the US Federal Reserve decided to raise its interest rate. Importantly for EUR/USD dynamics, the key factor was not only the 25 basis point hike itself, but also the rhetoric of new Fed Chairman Kevin Warsh, who back in late August signaled that the US central bank does not consider the inflation problem resolved.
Fed raises rates for the first time in years
On September 16, the US Federal Reserve raised the target range for the federal funds rate by 0.25 percentage points to 3.75–4.00% per annum. This was the first Fed rate hike in more than three years. The decision was expected by the financial market: the day before, market participants assessed the probability of a 25 basis point hike at more than 90%.
Therefore, the mere fact of the rate hike did not come as a surprise to the currency market. In such situations, investors tend to react primarily to the central bank's accompanying commentary and signals about the future trajectory of monetary policy.
That is why market attention is now focused on further statements by Kevin Warsh and the Fed's assessments regarding inflation, economic growth, and possible further rate hikes.
Why the euro came under pressure
The US rate hike increases the attractiveness of dollar-denominated assets relative to euro-denominated assets. If investors expect higher interest rates to persist in the US, demand for the dollar may increase.
After the Fed's decision, the dollar received additional support: according to Reuters, the US currency strengthened by about 0.4% against the euro, and the dollar index also showed gains. At the same time, the reaction was relatively moderate, since the rate hike itself had already been priced in.
For EUR/USD, this means that the pair's near-term dynamics will depend not so much on the Fed's decision itself, but on the answer to the question: is the US central bank ready to continue tightening monetary policy?
If the market receives a signal about further hikes, the dollar may get an additional boost while the euro may come under pressure.
Warsh had prepared the market for a rate hike in advance
Particularly important for the market reaction were the statements made by Kevin Warsh on August 28 at the Jackson Hole symposium.
In his speech, the Fed Chair made it clear that financial conditions in the US cannot be considered sufficiently tight, and inflation has not yet shown the necessary sustainable slowdown. Warsh said that the Fed still has 'work' to do in the fight against inflation.
After his speech, the market almost immediately began to increase expectations of a rate hike in September. According to Reuters, the probability of a 25 basis point hike rose from about 35% to 57.5% after Warsh's remarks.
Thus, the Fed Chair's August statements became one of the factors that changed currency market expectations in advance.
