The Federal Reserve maintained the interest rate at 4.25%-4.5% during its March 18-19 meeting and projects a reduction of 50 basis points in 2025. Fed Chairman Jerome Powell stated that the central bank would exercise caution regarding rate cuts, depending on the economy’s strength.
Current market predictions indicate a 15% chance of a 25 basis points rate cut in May. The Fed’s language shows a hawkish tilt, coinciding with a recovery in the US Dollar Index.
Federal Reserve Policy Goals
The Federal Reserve aims for price stability and full employment, primarily adjusting interest rates to influence economic conditions. It conducts eight annual policy meetings, attended by twelve key officials.
In times of crisis, the Fed may implement Quantitative Easing (QE) to increase credit flow, which typically weakens the US Dollar. Conversely, Quantitative Tightening (QT) involves halting bond purchases and can increase the Dollar’s value.
This decision to hold interest rates steady, combined with Powell’s cautious sentiment, signals that policymakers are prioritising economic steadiness over rapid adjustments. They are weighing inflation risks against labour market resilience, suggesting that any reductions may be slower than some had anticipated. The projection of a 50 basis point drop in 2025 provides a distant marker, but it does little to influence immediate rate expectations.
Current market probability assigns a low possibility to a cut in May, which aligns with the Fed’s relatively firm stance. This is reflected in the recent strength of the dollar, as traders adjust positions based on updated expectations. When interest rates remain stable or rise, the currency tends to retain its value, while cuts typically weaken it. Given the rhetoric from Powell and his colleagues, speculation around easing has lost momentum.
Impact On Financial Markets
We must also consider the broader backdrop in which these rate decisions are made. The Federal Reserve has a dual mandate: stabilising prices and ensuring employment remains strong. The twelve policymakers who attend its eight scheduled meetings each year assess a range of data, from inflation levels to workforce participation, to determine suitable policy responses. With inflation cooling but employment holding firm, they appear in no rush to loosen their grip.
During financial downturns, central banks have historically turned to measures like Quantitative Easing. This stimulates borrowing and spending but usually results in a weaker dollar. On the other hand, when Quantitative Tightening is in force, liquidity is removed from the system, leading to upward pressure on the currency. With the dollar displaying recent strength, this suggests that monetary conditions remain relatively tight, as policymakers exercise restraint before shifting gears.
For derivative traders, the changing probabilities of rate adjustments will be where attention should remain. If forecasts for a cut in 2025 remain intact but shift further out in time, yields may not drop as quickly as previously priced in. If economic indicators continue pointing towards resilience, expectations for sustained higher rates could gain traction, leading to a stronger dollar over the coming weeks. On the other hand, if there are any signs of deterioration in underlying conditions, pressure may mount on the Fed to act sooner than planned.
