Strengthening Fed Rate Hike Expectations Boost Dollar

ForexNewsNow | Published on December 12, 2016 at 1:12 am

The U.S. dollar rose Friday amid heightened investor expectations that the Federal Reserve will hike key lending rate benchmark this week. The Fed last raised interest rates in December 2015. Although investors initially expected the central bank to hike rates several times this year, mixed economic data would not allow such a move.

But Fed officials have recently sounded that the case for a rate hike had strengthened. Comments of economic outlook now supporting a rate increase came as some experts warned that the Fed risks overheating the economic by maintaining the lower interest rate condition for too long. Ahead of the Fed policy meeting this week, investors are assigning more than 97% probability the central bank would increase rates.

Upbeat hiring data and other economic indicators have strengthened expectations that a rate hike is coming soon.

Higher interest rates in the U.S. increase the appeal of the dollar as it boosts the demand of dollar-priced yield-bearing investments such as bonds. Yields on U.S. bonds shot up sharply in the days following Donald Trump’s surprise election as the 45th president of the U.S. Some worried surging yields would hurt dividends in companies that borrow to pay dividends.

Dollar index hits milestone

The U.S. Dollar Index rose 0.52%, touching to a fresh 4-day high of 101.64. The index measures the strength of the dollar against six major currencies including the yen.

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Analysts predict the dollar could rise further if Fed policy officials signal swifter increases in rates in the future.

Economic stimulus

A case for swifter rate hikes could be bolstered if President-elect Trump makes good his promises on economic stimulus. Trump promised to intervene to have U.S. companies keep jobs in the country instead of moving them to low cost countries like Mexico. He believes that keeping domestic jobs locally would lead to more employment for Americans, boosting consumer purchase power and corporate earnings.

Additionally, Trump proposed to allow U.S. companies with huge amounts of profits stored overseas to repatriate the cash at a lower tax rate. The President-elect reasons such a measure would allow the companies to invest the cash in the country, hiring more people and adding to domestic economic growth.

Some experts have said Trump’s proposed economic policies could fuel inflation, causing the Fed to raise rates more quickly. And higher interest rates will continue boosting the dollar.

The greenback was up 1.1% against the yen on Friday, touching a 115.33 mark that was last reached in February. Japan has maintained low interest rates as part of the quantitative easing measures to spur economic growth in the country.

But Japan’s currency would be rattled by higher interest rates because yield-seeking investors would pull their investment from Japanese assets and put the cash in dollar-denominated yield assets.

Impact on the euro

The common currency euro declined against the dollar last Friday. The euro was impacted by investors dumping the currency for the dollar amid heightened Fed rate hike expectations. Investors also sold the euro as it emerged that the European Central Bank will continue its bond-buying program.

While the ECB’s bond-purchase should help spur economic growth in the region because of easy, cheap cash, investors interpreted the latest move by the ECB as a sign of continued economic trouble in the region. Even before the ECB updated on its latest bond-buying program, some experts had warned the euro could lose its premium over the greenback in early 2017.

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