The US Fed’s rhetoric turns slightly hawkish and the greenback rallies. What changed since the previous Fed meeting to warrant the end of the accommodative monetary policy?

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In a stunning move to most market participants, the Fed turned hawkish last week. No matter how the Fed’s Chair, Jerome Powell, tried to downplay the message, the U-turn in the Fed’s policy has sent the greenback roaring.

More than twelve months have passed since the Fed announced the opening of USD swap lines in response to the COVID-19 pandemic. In the meantime, vaccines against the virus proved to be effective, and the financial markets were the first to react, with equities soaring to new all-time highs in America and most of the developed world.

The party came to an abrupt end last Wednesday. The Fed’s message, while covered in nuances, was nevertheless hawkish. In response, the dollar rallied across the board, gaining against its G10 peers. Moreover, the US equities declined, surprised by the hawkish shift in the Fed’s tone.

But a stronger economy and the end of the pandemic should, in the end, benefit equities. The only thing that scared investors was the surprise delivered by the Fed (too early to taper?), and the habit of depending on monetary stimuli.

What if, for once in the last two decades, the stock market should reflect the underlying economic conditions in the US economy? If that were true, the US equity markets should celebrate, not dive, on the Fed’s message.

Fed Forced to Acknowledge Positive Economic Developments

The Fed’s message, while surprising many, came in response to the recent positive economic developments. The US economy is reacting positively to the monetary and fiscal stimulus in response to the COVID-19 pandemic and the Fed did what it promised to do – it reacted to the economic data, no strings attached.

The real GDP forecast was lifted for both 2021 and 2023 at this June’s meeting. As such, the Fed expects 7% and 2.5% growth in 2021 and 2023 respectively, when compared to the 6.5%, and 2.2% forecast in May.

Moreover, both the unemployment rate and the inflation forecast justified a move from the Fed. Therefore, the Fed delivered, taking markets by surprise.

There is (was?) a strong belief in the markets that the Fed will remain accommodative for far longer. But in delivering its message last week, the Fed shows proactiveness rather than reactiveness.

It is now time for markets to adjust expectations to the new Fed’s policy.