All Eyes on the Fed
Weekly Foreign Currency Update
- On Wednesday, December 14, the Federal Reserve (Fed) unanimously raised the Federal Funds Rate for the first time in a year. Subsequently, the U.S. dollar strengthened against many of its peers.
- The dollar reached its highest level against the euro since 2003, and the yen continued its fall, as monetary policy diverged.
- While the increase in rates was widely anticipated, new economic projections from policymakers offered some surprises, pointing towards three interest-rate increases in 2017, up from two previously.
On Wednesday, December 14, the Federal Reserve (Fed) unanimously raised the Federal Funds Rate for the first time in a year, citing increased inflation expectations and a tightening labor market. The move increased the target for the rate to a range of 0.5% to 0.75%. Subsequently, the U.S. Dollar Index rose more than 2% against a basket of currencies, ending the day up 0.68%.
The U.S. dollar reached its highest level against the euro since 2003, and the yen continued to fall as monetary policy diverged. Last week, the European Central Bank (ECB) surprised investors when it announced the extension of its quantitative easing program through March of 2017, at which point, it would reduce its monthly asset purchases from €80 billion to €60 billion. Estimates suggest that the extension would add another €500 billion. Consequently, the euro traded down against the dollar. The Bank of Japan (BOJ) continues to keep rates low through asset purchases. The yen is down more than 12% against the dollar in the last three months.
The increase in rates by the Fed was widely anticipated by the markets – a near certainty, according to the Federal Funds Futures’ implied probabilities calculated by Bloomberg. Yet, new economic projections from the policymakers may have surprised some investors, suggesting a steeper path for U.S. interest rates than previously. The latest dot-plot proposes that the central bank expects to raise rates three more times in 2017.
Recent actions offer a reminder that central banks can be unpredictable. On Wednesday, the Fed shifted from being slightly behind the curve to slightly ahead of it.
Currency Movements Are Hard to Predict
Source: Bloomberg, 10/26/16–12/14/16. EUR/USD Spot Exchange Rate where the price of 1 euro is in U.S. dollars. The calculation is the one week percentage change in spot exchange rate where a negative value is the depreciation of the euro. JPY/USD Spot Exchange Rate–price of 1 Japanese yen in U.S. dollars. The calculation is the one week percentage change in spot exchange rate where a negative value is the depreciation of the JPY. The U.S. Dollar Index (USDX) indicates the general international value of the USD. The USDX does this by averaging the exchange rates between the USD and major world currencies. A negative value indicates a general depreciation of the dollar.
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