FX MONETARY POLICIES and employment hold strong.”
No special information was available to me here. My prediction was simply an exercise in understanding the fundamentals.
Why Did The Dollar Fall?
Considering what I’ve explained above, you might be asking why the US dollar fell following the rate decision.
Chart 1. US job creation since 2010 Analysing The Decision
So let’s look at why the Federal Reserve increased its benchmark rate. For starters, it highlights the strength of the US economy. Strong job creation, low unemployment and rising inflation have all contributed to a rate hike. Chart 1 shows US job creation since 2010.
But why do these things warrant an interest rate hike? Well, the answer is quite simple. One of the Federal Reserve’s primary tasks is to control how much US goods and services cost – known as inflation.
Te Federal Reserve’s target annual rate for inflation is 2%. March’s 2017’s core inflation rate was 1.7%. Tis is measured by the Fed’s preferred tool called the PCE price index. Tis means that prices for US consumers were 1.7% higher than they were in March 2016. Inflation occurs when more people spend more money –
26 FX TRADER MAGAZINE April - June 2017
something which is commonplace in strong economies.
Clearly, inflation is starting to creep towards the Federal Reserve’s target. By increasing interest rates, the central bank is encouraging investors, businesses and consumers to slow their spending. Fed chair Janet Yellen does not want to get behind the curve. In terms of price stability, it’s easier to hike gradually now as inflation approaches 2%, rather than allow inflation to overshoot. If inflation overshoots 2% the Fed may be forced to hike rate at a faster pace.
A few weeks back, I predicted that a rate rise would happen. Tis was despite the market judging that the chance of a rate rise was 25% for March: “I think we should be prepared for a surprise in March. Considering the recent rhetoric from Fed Chair Janet Yellen, I think there’s a chance we could see a hike. Tis is especially true if data releases for US inflation
Tis is an excellent example of why traders should be familiar with market sentiment 100% of the time. Te
truth is that an interest rate hike was widely expected in the days before the decision. While that’s good news for the US dollar over the longer-term, it was unlikely to strengthen in the hours aſter the Fed’s decision.
What professional investors were paying attention to is the Fed’s new Dot Plot chart. Te last Dot Plot chart, published in December 2016, told us to expect three interest rate hikes in 2017. Te new Dot Plot chart didn’t change this forecast. Tis is why the US dollar fell. Tere was an expectation that more than three interest rate hikes for 2017 could be possible. Te market became over excited on the prospect of more than three hikes. When that expectation met the Fed’s reality of only three, the USD weakened.
Future Interest Rate Hikes
So two more interest rate hikes are on the cards for 2017. Again this is a
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