Chairwomen Janet Yellen and the US Federal Reserve Board (Fed) finally delivered the market what is was looking for with a 25 point interest rate hike. But what came after at the Press Conference turned this Hike into so much more.
The Fed Forecasts show they are expecting to continue to Hike in 2016 and for inflation to remain low due to the forecasts of a stronger dollar. However the kicker came when Janet Yellen indicated that data will determine the pace of future rate hikes and that in fact hiking was good because that gave them the opportunity to cut in the future if needed.
This is an incredibly complex decision as with the Fed having such an enormous investment in the economy some wonder just how far interest rates will actually raise in the market with such a pool of securities available for repo. In the larger economy Wells Fargo announced they would hike their Loan Rates immediately while leaving Savings Accounts untouched and again. It shows that for the Fed to really alter decision making they will have to continue down the path they have started.
In the Forex Markets the dollar rotated through a 1.5% Range and really the actual market prices are within +/- 0.5% of our closing prices here in Asia yesterday.
What typically occurs when economies start to move in different directions is the forward market starts to factor in the movement of interest rates and while the spot rates may fluctuate eventually they zero into the fact that trading costs are starting to move.
Importantly for our market and the Australian Dollar (AUD) what we are going to see is our Yield advantage decrease and exporters not being able to hold AUD unless their export contracts are rock solid and fully deliverable. For importers the cost of hedging longer term will decrease and the balance between these 2 will shift for the next 12 months… providing less support for the AUD.
For the European Currencies we know that their rates are a more complex environment feeding a need for full recovery but hampered by the fact for the next 12 months the US Dollar (USD) will remain king. This currency basket of trading is going to remain buoyant due to the strong export performance of large European corporates who are enjoying the benefits of lower Euro (EUR) but still hampered by the interest rate effect on spot prices.
The larger question here is what happens in 12 months if the Fed stops hiking and the data supports a more neutral stance or a possibility of even a cut .. This will be the time where we will see the commodity cycle turn and the USD will start weakening again as more global economies start to feel recovery and monetary easing in those economies is turned off.
Importantly for us here in Australia we can never underestimate the Chinese reaction because we are so tightly aligned to the fortunes of their economy. The test will come into 2016 when the full recent drop in commodity prices will be open for rollover of securities tied to those industries.
* USD is data dependent into 2016 – NFP above 200k will indicate faster hikes
* Hiking rates also allows the Fed to cut if needed
* USD to remain strong for 2016 but 2017 tends more towards weakening
* AUD will more depend on China than the US as commodities play a much more important role here
* Wells Fargo hikes Home Loan Rate keeps Savings Accounts unchanged.
* Fed has 2.6 Trillion Balance sheet