Dollar Rises As Fed Minutes Signal More Tightening Ahead

Federal Reserve is the most important central bank in the world. This is mostly because of the central role the USD plays in the global economy because it acts as the reserve currency. Therefore, any decision the Fed makes usually leads to major impacts around the world. When the Fed tightens, the supply of the dollar is usually constrained, which may or sometimes leads to weaker global currencies. When it eases the monetary policy, it makes borrowing cheap which may or sometimes leads to a weaker dollar.

After the financial crisis of 2008/9, the Federal Reserve intervened by lowering interest rates. It brought them to zero and implemented the quantitative easing program. The QE was essentially a process of printing money to buy assets such as mortgage backed securities. This move was copied by central banks from around the world as well.

In 2015, under Janet Yellen, the Federal Reserve started to a process of normalizing interest rates. This was less than a year after the Fed ended the QE program. In the new phase, Yellen and the team said that they would increase rates in a gradual phase. The goal was to bring interest rates to a higher level with the aim of having a buffer against any major crisis.

Since 2015, the Fed has continued to increase interest rates. Already, the Fed has implemented eight rate hikes and it is in the process of raising in December. In 2019, the Fed forecasts three more rate hikes. In the minutes released yesterday, all the members were of the view that more tightening was needed. The statement said:

With regard to the outlook for monetary policy beyond this meeting, participants generally anticipated that further gradual increases in the target range for the federal funds rate would most likely be consistent with a sustained economic expansion, strong labor market conditions, and inflation near 2 percent over the medium term.

It added:

A few participants expected that policy would need to become modestly restrictive for a time. A couple of participants indicated that they would not favor adopting a restrictive policy stance in the absence of clear signs of an overheating economy and rising inflation.

This statement did not go well with the US president who has accused the Fed of working against his agenda. On Tuesday, he said that the Fed was the biggest threat to his economic progress.

There is some truth to what the US president is saying. As shown below, most recessions happen at a time when interest rates are rising. This usually may lead to an intervention by the Fed to lower rates.

In addition, there is a question about the urgency for the continued tightening. This is because other central banks have not moved from the low interest rates. In fact, the BOJ has said that it will leave the negative interest rates for a longer period.

Trump is also worried about the impact of the dollar on trade. A stronger dollar is usually not supportive of the US manufacturing industry. A strong dollar leads to the products exported from the USA to be a bit expensive.

After the Fed minutes were released, the dollar index rose as shown below.

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