Is the Dollar Rise Over So Soon?

After more than a year of waiting the U.S. Federal Reserve finally raised interest rates by half a point last week. And now, rather than expecting a healthy increase in the value of the USD it might fall. Is the dollar rise over so soon? It would appear that the market had already factored in most of the increase of the value of the dollar and hedge funds are already betting against the USD. Bloomberg Business says that the dollar is ready for the first monthly decline since August against the Euro.

The dollar is on pace for the first monthly decline since August as investors bet the Federal Reserve will wait until at least April to raise interest rates again after last week’s liftoff from near zero.

Hedge funds reduced futures bets for a second week that the dollar will advance against the 19-nation currency, in the last positioning data available before the U.S. central bank raised its target for the first time in almost a decade on Dec. 16.

The dollar has gained against almost all major currencies this year as investors prepared for the Fed to tighten monetary policy while other central banks added stimulus. Yet U.S. policy makers have emphasized that they’ll stick to a gradual pace of rate increases to assess how the economy responds to higher borrowing costs and as commodity prices tumble. Brent oil touched its lowest since 2004 on Monday.

Two factors are tempering the rise of the dollar. One is that the market had already factored in the rate increase. The other is that the Fed promises to go slow and assess the response of the economy to higher rates. The market remembers that the Fed first mentioned a rate increase a year and a half ago. If this is the pace at which the Fed will use higher interest rates to preempt inflation traders appear to be safe betting against a huge rise in the dollar or even a retrenchment.

The Risk of Higher Interest Rates

The dollar rise appears to be over so soon because the Fed intends to go slow with any further raising of rates. What could go wrong with higher rates asks The New York Times. They talk about recession and its causes, fire or ice.

In the past, the culprit has frequently been fire – an overheating economy and rising inflation – that prompted the central bank to push up interest rates until they ultimately choked off growth. Ice is more unusual, at least in the United States, but often more painful, as excess capacity, weak demand and falling prices foster a deflationary slump that can prove difficult to escape.

As the Federal Reserve embarks on a new chapter in monetary policy, having raised rates on Dec. 16 for the first time in nearly a decade, policy makers are acutely aware of the risks posed by either possibility.

“Raising rates the first time may have been the easy part; now comes the challenging part,” said Mike Ryan, chief investment strategist for UBS Wealth Management Americas.

Fed officials do not have to look far for real-world examples of what can go wrong.

European central bankers raised rates twice in 2011, killing off a nascent recovery and plunging the Eurozone into a double-dip recession that it is still struggling to overcome.

The point for the Fed is not to choke off the recovery while still containing inflation. For Forex traders the task is anticipating the Fed.

A Little Perspective

How high is the Fed’s key rate normally? Since 1954 it has averaged 5%. The so-called historic rate hike is miniscule in comparison to other increases in the last twenty years. The Market Oracle reproduces a graph from the St. Louis Federal Reserve showing the Fed key rates from 1995 to now.

Taken in perspective this is not a huge rate hike which may explain why the dollar rise is over so soon.