US dollar falls and bonds rise after Federal Reserve raises rates but says future moves would be 'gradual'

The dollar index, which measures the currency’s strength against a broad spectrum of other currencies, slumped to a three-week low

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The dollar fell sharply while US government bonds enjoyed their biggest rally in around nine months after the Federal Reserve on Wednesday raised interest rates for only the third time in a decade, but signalled that it would proceed cautiously going forward.

The Fed lifted its funds rate by 25 basis points, as expected, to a range of 0.75 per cent to 1.00 per cent, but said further increases would only be "gradual."

The central bank’s chief, Janet Yellen, also said that the Fed was sticking to its forecast for two more hikes in 2017 and three more in 2018. A large proportion of economists had expected a pick-up to these projections.

Immediately after the decision, the dollar index, which measures the currency’s strength against a broad spectrum of other currencies, slumped to a three-week low of 100.510. Higher interest rates generally support a country’s currency.

“With the scale, mix and timing of any fiscal stimulus still very unclear, the Fed is right to be cautious with the pace of tightening, despite some robust economic data in recent weeks,” said Ian Kernohan, an economist at Royal London Asset Management.

“We expect more rate hikes this year, which should be supportive of the dollar,” he added.

Tom Stevenson, investment director for personal investing at Fidelity International, said that “the Fed is clearly erring on the side of caution”.

Two-year US bond yields recorded their biggest daily drop since last June overnight, as bond prices rose. Forecasts for more rate increases would likely have spurred bond yields.

A sigh of relief also echoed through emerging markets. There had been fears that a quicker rise in interest rates in the US would have led investors to pull more money out of higher-yielding funds in riskier markets.

Elsewhere, the euro climbed after Dutch politician Geert Wilders won fewer votes for his anti-EU party than expected in the country’s election.

Barclays economist Fabrice Montagne wrote in a note that this suggests “that the rise of populism and fragmentation has been contained and bode well for the elections to follow across Europe”. 

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