Following the U.S. Federal Reserve meeting of October 2015 that favored the aggressive approach, it seems we could see an uptick of interest rates by December 2015. Although consumers usually see an increase on loan interest, overall, this could be a good thing for the economy.
Actually, rising rates can be a good thing and an indication that market growth is moving forward. In fact, it could signal greater corporate spending and employment, engendering confidence along the line. So, exactly how does the rise in interest rates affect the US dollar’s rating?
Currencies Respond Well to a Rise in Interest Rates
Interest rate decisions cause a significant impact on the performance of currencies. This, combined with trade balance, gross domestic product (GDP) and unemployment statistics, can bring about drastic movement, one way or the other in the currency markets. For example, after the Federal Reserve raised rates from 1990 to 2015, the US dollar was severely weakened, contrary to traditional expectation.
In 1994, the US dollar sank as the Federal Reserve began to up interest rates until the beginning of 1995. The dollar began to rally again and, by 1997 with new hikes, continued strong through 2001. Because of the two recessions that happened from 2003 to 2006, the US dollar lost value during the last rising rate cycle. So, although, generally speaking, rising interest rates are a boost for currencies, we have the federal funds rate increase over the last 25 years to blame for an unexpectedly low correlation.
Next Rate Increase will Probably not Affect the U.S. Dollar
We should not look for a rise in the value of the dollar again with the Federal Reserve’s announcement of a rise in interest rates. As the US dollar is at a peak, we will see that rate increases will have low to no correlation with it and may even pose a negative impact.
There has been a big rally in the dollar from about $81 to the current value of $97.59 just since the end of 2014. There was even a point when the index went above $100. Investors who were expecting a rate increase over the past year were not disappointed. Now, market analysts predict the probability of very little movement in the dollar as a result of increase in rates.
What are We Looking at?
What we’re not looking at is the likelihood of an increase in the value of the dollar. Over the last eight years, with prevailing low interest rates and sluggish growth in the economy, the US dollar rallied itself to an all-time high against other market currencies. The rise in interest rates will probably not push it up any further. Higher rates will, however, encourage more confidence in the economy. Investors looking for additional dollar strength may be disappointed. The reality is that higher interest rates may level out the value of the US dollar or even cause a slight dip in the currency.
