How High Will the Dollar Go in 2016

After a year and a half of talking about it, the U.S. Federal Reserve will probably raise interest rates in December of 2015. The USD is already going up on expectations of the interest rate increase. The question we ask for Forex traders is how high will the dollar go against a basket of currencies. And, how high will the dollar go against specific currencies? As an example, the Sydney Morning Herald quotes Goldman Sacks as believing that the upcoming dollar rally will be a major risk to the Chinese economy in 2016.

A renewed downturn in China and a rapid acceleration in the United States dollar are the two big “spillover” risks the global economy faces in 2016, according to Goldman Sachs’ top economist, as the great divergence in monetary policy begins.

The Chinese yuan is pegged to the US dollar through a daily fix set by officials, meaning it chases the greenback higher when the US dollar advances. That supported the case for a depreciation of the yuan in August by Chinese authorities, because yuan appreciation had made China less competitive against Japan and Korea whose currencies have fallen.

“We think the biggest risks lie in spillovers from a sharp slowdown in China and/or a large [US] dollar appreciation,” Goldman warns. “Our modelling work shows that both would likely hit China hardest.”

It was a shock to Forex markets in August 2015 when China let the yuan devaluate. And they may have to do it again if the dollar continues to climb. But, again, how high will the dollar go?

How High?

How high the USD goes will be related to how high the Fed raises interest rates. According to Bloomberg Business the Fed will raise rates slowly and keep rates unusually low for the next few years.

The Federal Reserve is widely expected to raise interest rates next month, a move that some worry would make it harder for the central bank to achieve its goal of 2 percent inflation.

Wall Street says worry not: A newly released survey of the nation’s biggest bond dealers suggests Fed policy will be easy for years, even after a series of rate hikes.

Bond dealers expect to see rates go up to 1.5% over the next three years. What does this translate to in dollar strength?

Interest Rates and Exchange Rates

It turns out that no one is predicting an exact amount by which the USD will rise when rates go up. This is not really a matter of fudging but rather reflective of the mix of factors that come into play. Investopedia looks at changes in national interest rates and Forex exchange rates.

All other factors being equal, higher interest rates in a country increase the value of that country’s currency relative to nations offering lower interest rates. However, such simple straight-line calculations rarely, if ever, exist in foreign exchange. Although interest rates can be a major factor influencing currency value and exchange rates, the final determination of a currency’s exchange rate with other currencies is the result of a number of interrelated elements that reflect and impact the overall financial condition of a country in respect to that of other nations.

How high will the dollar go? Watch what happens when interest rates go up and watch to see if the economy gets better or worse.