Fed Interest Rate Hike: The Canaries Are Quiet by 720 Global
In the late summer months of 2015 the Federal Reserve were actively discussing the possibility of raising the Federal Funds rate signaling a reversal of their prolonged, zero-interest rate, crisis management attitude towards monetary policy. The prospects of rising U.S. interest rates occurring while many central bankers were actively lowering interest rates and/or printing upset the global financial markets. In mid-2014 when this policy divergence was first suspected by market participants, the U.S dollar started rising against most currencies. The trade weighted broad dollar index rose approximately 15% from mid-2014 to mid-2015.
As 2015 progressed, markets around the world were slowly taking notice of the dollar’s ascent and pricing in the economic side effects. As a side bar to help better understand why the strength or weakness of the U.S. dollar (USD) is so important to the global economy we share a paragraph from an earlier piece we wrote: “The volume of USD borrowed, for foreign purposes, is heavily dependent on the value of the USD relative to other currencies. In the scenario where the foreign currency strengthens relative to the USD, the foreign denominated funds required to re-pay the USD loan decrease, effectively lowering the cost of borrowing. Conversely, during periods of USD appreciation borrowing in USD is not as popular as the cost-benefit to foreign borrowers and U.S. based investors is reduced. Consequently, USD strength or weakness heavily influences borrowing in currencies of all types, and thus international monetary supply. In a global economy, largely dependent on debt, monetary supply is the fuel governing the pace of the global economic engine.”
To summarize, U.S. dollar appreciation is the equivalent to global monetary tightening.