Forex Trading Strategies Blog

The new US Fed chief notched up interest rates in the US further by 25 basis points taking them to 4.75%. He did this to keep inflation under leash and has hinted that rate increases are likely to continue. This hike is in continuance with his predecessor’s interest rate policy and is the 15^th successive increase in interest rates. Allan Greenspan began hiking rates from their 1% level in mid 2004.

The British pound lost ground to the US dollar on this news as also the announcement of an increase in the UK’s current account deficit. The US interest rates, now at 4.5%, are higher than the UK's. With further likely increases in US interest rates in the future, experts feel that the US dollar is all set to overtake the British pound in the coming years.With this hike the gap between the US and Australian interest rates also narrowed and the US dollar rose against the Australian dollar as well. The Australian Dollar slipped to a three year low of US 70.2 cents.

While the US economy has shown no signs of slowing down, the successive interest rate hikes have dampened the US realty market. Experts have termed the sustained boom in this market as a bubble waiting to burst. Hardened property prices had led to a lot of borrowing against homes. These borrowings have sustained consumer spending and the economic boom in the US.

The US Fed will have to be cautious, while planning further hikes as any further increase in interest rates can prick the property bubble and destabilize the US economy.

To read further on the Fed’s latest hike, click here.

We have all read about China’s huge forex reserves vis a vis its highly undervalued currency and the US Dollar being overvalued in the face of the nation's huge current account deficit. According to traditional economics, for both these nations, the situation is unsustainable, and correction in their currency values is imminent.

A problem with economists is that they tend to rely too heavily on text book theories, and sometimes do not move with time to adapt these theories to a changed world. Most of the theories on the current account deficits and currency values were written when economies were still isolated and markets were not as yet so global.

Let’s study how investment and production work within the boundaries of an economy. The savings that the nation generates get ploughed back in the form of investment and it becomes a virtuous cycle. A healthy banking system facilitates this cycle, setting it onto a high growth path.

However, with the onset of globalization, things can begin to look different. China has accumulated a lot of savings in the form of forex reserves. China uses these reserves to buy US Government treasury instruments. This helps China keep the value of its currency low and at the same time keeps interest rates in the US low. Low interest rates fuel consumption growth.

US that is fulfilled to a great extent by China. Production in China is also driven by US MNCs that bring in technology and capital. In a way the US is acting as an efficient bank for the bi-economy set up. So the relationship can be termed sustainable and the two currencies can continue their anti-theory trends.

To read further on this, click here.

The US Fed on Tuesday, Jan 31, 2006 raised the interest rates by 25 basis points to 4.5 percent. This is highest ever since May 2001. It is widely believed that this hike will be the last in a series of 14 consecutive hikes. Coincidentally, this hike also brings Allan Greenspan’s term as the Chairman of the US Fed to an end.

No hikes in the future or a reduction in the interest rates would mean a softer dollar regime, which is also in line with the massive current account deficit that the US has.

For the consumer, while borrowing money may get cheaper or may stay stable under the new interest rate regime, a softer dollar will mean an increase in the cost of imported products and the US is the largest importer in the world! Not a very happy situation!

The US dollar, considered the world’s reserve currency, is a reflection of the strength of the US economy. The US economy is the largest economy in the world and quarterly growth results tend to impact the value of the currency in the short term. Another key factor that affects the value of the dollar is the interest rates that the US Fed sets. If the Fed raises the interest rates, people would want to invest more money in government treasury bonds and the demand for the dollar goes up. People would sell other currencies to buy dollars leading to an increase in its demand. As the demand goes up, its price goes up, which gets reflected in a strengthening of the dollar. The opposite happens, when rates are reduced.

However, markets never wait till the Fed actually makes the announcement or till quarterly growth results are released. Markets factor in expected information and the dollar moves in anticipation. On Jan 27, markets factored in an anticipated strong-growth announcement and the US dollar moved upwards.

Another factor that is upping the value of the dollar is the anticipation that the Fed will raise interest rates in the coming week to 4.5 percent. However, the Fed has been raising the rates continuously for over a year and the expected medium term trend is that the Fed will not be raising rates after the next hike. This broad expectation has led to an overall dampening in the dollar through the last few months.

After the recent release this week, of the FOMC, the US dollar dropped the lowest in one day since Sept 11, 2001 during this week of trading.

The dollar was steady when trading began in 2006, but the looming FOMC report and subsequent hint that the Federal government has will increase interest rates, rattled investors who quickly sold the dollar before the report was released.

This did occur and the interest rate was increased by 4.25 pct. The dollar continued to remain low, especially after the release of weak economic data for the manufacturing industry, and the higher oil prices have not helped to strengthen the dollar.

In anticipation of the Federal Reserve minutes that will be released today, the dollar dived as many investors returned to work from their holidays and began selling the dollar.

The Federal Reserve minutes is expected to be released at the FOMC (Federal Open Market Committee) meeting. It is during this meeting that market analysts have been predicting that the Feds will use these minutes to announce an interest rate hike.

The minutes combined with the release of the ISM index, which showed a decline in December from 58.1 in November to 54.2 in December, did not help to keep the dollar strong.

The euro traded against the dollar at $1.1968, which is 1.2% higher than yesterday. However, the dollar fell against the Yen by 1.3% to 116.33. However, the greatest change was seen when the dollar dropped when traded against the Swiss franc to 1.2934 francs. This was the lowest its traded at in the last two weeks.

The dollar was strong today, as the world entered a New Year. However, economic analysts advised that much of the US and the UK are still on holidays and this has helped the dollar to remain firm.

However, as previously discussed in the blog, it is expected that the Federal government will announce an interest rate hike sometime tomorrow or by the end of this week, which will greatly affect the dollar. According to Michael Klawitter, strategist at WestLB, “Tomorrow’s FOMC minutes are expected to emphasize the solid growth and potential inflationary impact in the US economy, thereby leaving the door open for hiking fed funds beyond 4.50 pct,” Klawitter stated.

Other than the increase in the interest rates, the monthly ISM survey will be released outlining an increase of 200,000 jobs. This will also have an impact at value in which the dollar is traded at.

As noted in previous blogs, it will be also interesting to see how the possible upcoming announcement of an increase of interest rates by the ECB will affect the dollar and the European currencies it trades against.

At the end of the trading season for 2005, the dollar is trading higher, and at the level it is currently trading at, it has had the highest gain against the euro since 1999. This is also the highest it has traded at against the yen in the past two decades.

It was shown to be trading against the euro at $1.1823 since yesterday, however the dollar gained 0.2% at 117.99 yen when traded against the yen.

The high rate of the dollar has been due to the fact that its been “piggy-backing” on the constant raises in the interest rates, which is scheduled to be raised again to 4.5%. When traded against the Swiss franc, the dollar was up by 0.1%, trading at 1.3154 francs.

Based on this, analysts are recommending a strong year for the dollar, even though they are predicting it will weaken in the later part of 2006.

After the release of the recent inflation news, there was no change in the dollar after its recent fall.

The Federal interest rate has been rising steadily and it is predicted that the rate will also be increased by the in January as well.

However, today the dollar remained steady against the Euro, but was down when comparing it to the yen. It was found to be 0.4% than its previous trade against the yen.

Also when compared with the Swiss francs, the dollar remained steady at an exchange of 1.3125 francs.

Beyond this, the only other major currencies that the dollar traded higher at were the New Zealand and Australian currencies.

Market analysts had expected more favorable results with the release of the University of Michigan’s consumer sentiment index for December which was higher than average at 91.5.

The currency market continues to look for direction. After reaching 27 month high against the Yen and 2 year high against the Pound Sterling the US Dollar traded downward. Recent data suggests the US real estate market appears to be cooling quicker than expected, which in turn might make the fed be a bit more cautious with raising rates. Bloomburg reports:

The dollar dropped against the euro and the yen after an industry report showed U.S. home sales in October fell more than analysts forecast.

The report may damp speculation about how many more times the Federal Reserve will raise interest rates. The Fed has lifted rates 12 times since June 2004 to 4 percent from 1 percent, helping the dollar gain more than 15 percent against the euro and the yen this year.

Read more: Dollar Declines After U.S. Home Sales Fall More Than Forecast