Volatility In The Currency Markets: The Fed Decision And Beyond

Finally, something predictable has happened in 2016! The Federal Reserve raised interest rates by a quarter of a percent this month, making it the first hike for a year and just the second since the 2008 crash. As anticipated, the Fed’s vote on this was unanimous.

Future Rate Hike Projections

Looking closer, a single 0.25% rise over the space of a year is hardly life-changing. Perhaps the more significant data revealed by FOMC members on December 14 was their ‘dot plot’, which showed upgraded forecasts for future rate hikes.

While September’s dot plot anticipated two hikes of the federal funds rate in 2017, in December’s this increased to three. The FOMC has also upgraded its expectations for the federal funds rates in 2018 and 2019, with three rises expected in each year.

Why The Rate Hike Was Small

On the surface, these hawkish expectations point to a growing confidence in the U.S. economy. It has, after all, seen unemployment fall and is enjoying buoyant economic growth. While the FOMC’s statement made no reference to the recent election of Trump, the president-elect’s plans for tax cuts and infrastructure investment and how these could drive economic growth will have been on their radar.

In reality though, an air of uncertainty must surely hang thick in the corridors of the Federal Reserve. Until the Trump administration is up and running and the intricacies of its monetary policy are clear, we shouldn’t expect anything drastic to occur. Hence the ‘small’ token rate rise.

How The Currency Markets Were Affected

On the other side of the Atlantic, the immediate effect of December’s rate rise was typical - the weakening of Sterling against the dollar. That said, Sterling still held above the 31-year low it hit in October. By contrast, the euro tumbled to a 14-year low against the dollar and markets were wondering if we were headed towards parity between the euro and the US dollar. The Dollar Index hit its strongest position in 14 years, which is great for reducing the cost of imports but damaging for exports as it makes them less competitive.

We Are In For A Volatile 2017

Looking ahead to next year, while the U.S. waits for clues of how the Trump administration will unfold, the UK and Europe have the longer, more excruciating process of Brexit to work through. Inevitably, monetary policy will be dictated by this. No surprise that the Bank of England left interest rates at 0.25 percent in December and, along with the European Central Bank, is expected to leave rates well alone for at least a year to 18 months, highlighting further the policy divergence developing between them and the U.S.

Expect the run-up to March 31 when the UK government has pledged to trigger Article 50, beginning the process of its departure from the European Union, to be especially unsettled.

If we wish for anything in 2017, even if we must wait until the end of the year, a sense of stability should surely be at the top of our list. Predictability and consistency help businesses, as well as individuals, plan financially. Sadly this has been seriously lacking during 2016.

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