US Dollar Will Strengthen As Fed Funds Rate Rises
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The 34-year chart below clearly demonstrates that in general the US Dollar Index runs parallel to the trend of Fed Funds Rate (1984-Present). Although there is a material time lag in some years, the long-term trends of both run in tandem.
There is an important reason for this long-term ‘Tango Dance Duo’ between the Fed Funds Interest Rate and the greenback. The following analysis paints a realistic picture for this.
Fed Chief Paul Adolph Volcker
During the late 1970s and early 1980s there was rampant inflation in the US. To alleviate this dire economic weight, Fed Chairman Paul Adolph Volcker forced interest rates to dramatically decline under Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987 with a view to systematically drive historically high inflation down to acceptable levels. Understandably, the value of the US Dollar dramatically crashed during the process (as the above chart shows).
Fast Forward To Fed Chair Janet Yellen
Today’s Fed Chair Janet Yellen is plagued with the reverse of the ‘inflation coin’ – i.e. the inflation rate is too low after six years of the Fed Funds Rate graveling about the ZERO level. Consequently, the US Fed recently began to slowly and methodically to increase the Fed Funds Rate since mid-2015 (See 3-Month US Treasury Yield vs US$ Index chart below).
http://stockcharts.com/h-sc/ui?s=%24IRX&p=M&yr=7&mn=3&dy=0&id=p92787707667&a=456068073&listNum=1
Indubitably, Yellen’s policies have effectively increased the Fed Funds Rate from well-nigh ZERO to 3.23% from late October 2015 to the present. Moreover, ardent financial students will take careful note that the value of the US Dollar Index soared 20% from 80 to 96 as interest rates were rising.
Important Note: 3-Month US Treasury Yield vis-à-vis Fed Funds Rate
Short-Term US Treasury Bill Yields are closely influenced by the Fed Funds Rate. You can rely on them to move up and down together with the Fed Funds Rate.
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This Begs The Question: Will The Fed Continue To Increase Interest Rates?
“While consensus for the first US Federal Reserve rate rise is leaning towards September, a growing number of market watchers are suggesting that, before the year is out, two interest rate hikes rather than just one could be on the cards.
A number of officials from the central bank have already suggested that two rate rises are possible this year, but economists and investors assessing the economic data are now also leaning in favor of two hikes.
Earlier this month, San Francisco Fed President John Williams said his preference would be for two rate hikes before the end of the year, echoing comments he made in June.
Meanwhile, Fed governor Jerome Powell also said he was prepared to raise interest rates twice this year in September and December as long the economy continues to perform as expected. The Fed has kept interest rates near zero since late 2008.
"My base case is they hike in September, with two hikes before the end of the year. The market is not really fully priced for that, so a hike in September will be dollar positive," senior foreign exchange strategist at ANZ, Khoon Goh told CNBC.
"I think for September, the market is only about 10 basis points priced in, "meaning a large portion of the market are not positioned expecting an interest rate rise," Goh said, which could push the dollar index against a basket of currencies above the 100 level, up from its current levels of 96.5.” (Source: http://www.cnbc.com/2015/07/28/what-two-fed-interest-rate-hikes-could-mean-for-markets.html
Fed Funds Rate vs US Dollar Index
Without question the Fed is slowly and methodically raising the Fed Funds Rate, which is driving the US greenback higher. Moreover, we may count on this hawkish Fed policy to continue for the foreseeable FUTURE.
Rest assured Fed Chair Yellen will be forced to continue to raise interest rates several times before she leaves this coveted post…as she “orchestrates” her future legacy. Indeed as the Fed Funds Rate increases, thus fueling higher levels of short-term US Treasury Yields, accordingly the US Dollar Index will continue to rise with a possible price objective of 120 sometime in the near future. As history is testament, the quid pro quo for rising interest rates is a strengthening US Dollar Index.
Conclusions
In the event interest rates continue to swing higher (as the above analysis indicates), it would really hammer Wall Street equities – especially high-yielding dividend stocks. The 2009-2016 bull market in stocks is possibly one of the longest in financial history. To be sure ALL bull markets eventually and inevitably end…and are usually followed by substantial corrections. EXAMPLES: The 2000-2002 Bear Market saw the DOW Index drop approximately 40%...while the 2007-2009 Bear Market slammed the DOW Index down 54%. To be sure a new Bear Market in stocks might see the DOW suffer an egregious loss by plunging down to retest its March 2009 low at 6500. This is a plausible forecast estimate as today’s Price Earnings Ratios are at unreasonable, astronomical levels. Today’s levitated PER of the S&P500 Index at 25:1 is higher than it was in October 1929 - just before the horrific crash that hammered stocks down -89% during the following three years. (Source: https://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929 )
Indeed a day of painful and sorrowful reckoning is on the horizon, which will cause grievous financial and mental anguish for all Pollyannas, who are naively optimistic about the future due to their inexcusable ignorance. Specifically, a possible September/October 2008 Black Swan déjà vu looms on the Horizon.
Related Research
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