Sunday, December 13, 2015

All eyes are on the U.S. Fed this week | The argument for a continuously strengthening dollar

The Forex and other markets have been well-prepared for the initiation of a new interest rate cycle of rises in the U.S. The first of these is widely expected to be announced at the end of the December Federal Open Market Committee meeting, which concludes on this coming Wednesday, the 18th. This rise will crystallise the divergence between U.S. monetary policy and that of the next most important global currency bloc, the Eurozone. This divergence began with the so-called tapering of U.S. Quantitative Easing, which was finally accomplished in October of 2014. The Eurozone, while also employing the low interest rate tool of economic enhancement, is only now getting into its stride in terms of Q.E.

This divergence can be seen as the driver of continuing weakness in the Euro as against the US dollar. However, the Fed has also been at pains to emphasise that once the rate tightening cycle starts, it will only be implemented very slowly and in small increments. There is also nothing to say that it might not even be put into reverse from time to time. Such a climate can only provide a brake to Single Currency depreciation against the U.S. dollar.

The argument for a continuously strengthening dollar

But now a closely argued piece in the Australian “Business Spectator”, by Victoria Theiberger, entitled “The Fed’s tightening path may jolt sanguine investors” (it is behind a paywall but readers might think it worthwhile to pony up the small amount required) maintains that the rate rise regime in the U.S. is going to strengthen during the coming year rather than weaken. This is based on the belief that the rotation of voting members of the FOMC will bring far more hawkish members into a position where they can directly influence events; that U.S employment growth is robust and improving to a degree that might be underappreciated at present; and that low interest rates are actually now a drag on the economy rather than a stimulus. Thieberger rationalises this last thesis by stating that the near-zero rates have sharply increased the cost of retirement, meaning that the very many retirees in the US have had to save harder and for longer in order to achieve the same income when they finish their working careers. Some economists, such as Drew Matus of UBS, believe, for this reason, that “… the first few rate hikes may cause an acceleration in economic activity rather than acting as a restraint”.

If this turns out to be the case, the Fed will grasp the opportunity to get interest rates back quickly to what had been regarded as “normal”, prior to the establishment of what many are seeing as the “new normal” of near-zero rates (When you hear that term becoming mainstream, you can be pretty sure that the market is getting ready to create yet another surprise for the unwary).

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