Currency Reacts as Fed Raises Rates
- On Wednesday, March 15, as everyone expected, the U.S. Federal Reserve (Fed) increased the Federal Funds target range by 25 basis points to 0.75% – 1.00%.
- Surprisingly, the dollar fell on the news, as investors pulled back on bets that interest rates would rise at a quicker pace in the future.
- Moving forward, the Fed anticipates hiking interest rates two more times in 2017, three more times in 2018, and another three in 2019, assuming 25 basis point hikes. Meanwhile, other central banks are maintaining the status quo.
On Wednesday, March 15, the Federal Reserve (Fed) announced that it would raise the Federal Funds Rate, the benchmark interest rate it controls, by a quarter of a basis point. Financial markets had widely anticipated this move leading up to the Federal Open Market Committee’s meeting, and many investors had revised their rate expectations higher. However, statements from Fed Chair, Janet Yellen, were seemingly less hawkish when forecasting future action. As a result, the dollar moved lower against a basket of currencies.
The U.S. economy has been on a roll, as of late. Manufacturing activity is elevated, capital expenditures are up sharply, and corporate revenues and earnings are rising. In her speech following the meeting, Yellen cited that “job gains have remained solid”, “household spending has continued to rise”, and business-fixed investment “has firmed somewhat”. Moving forward, the Federal Reserve expects to remain data dependent, while targeting its dual mandate of 2% inflation and full employment. The committee expects economic conditions to continue to warrant gradual increases in the Federal Funds Rate – including two more this year. The markets currently expect that the path of interest rates will be significantly lower.
Dollar investors will continue to monitor the Federal Reserve, but fiscal policy is becoming an increasingly important part of the mix for investors. The appreciation of the dollar was predicated on both fiscal stimulus and rising rates. If the President’s policies lead to higher economic growth and inflation, the Fed may need to move rates higher at a faster pace. However, any policy failures could drive interest rates and the dollar lower.
Currency Movements Are Hard to Predict
Source: Bloomberg, 1/24/17–3/15/17. 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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