Home US interest rate cycle close to turning – should

US interest rate cycle close to turning – should

In the dry world of monetary policy something very significant is happening – the US interest cycle looks close to turning and when it does it will be a historic event which could further realign forex levels.

Versus a basket of currencies, USD is already at its highest levels since 2010 and has the capability to go higher still. This time it is gaining on good news rather than acting as a safe haven for frightened capital.

The press releases relating to the FOMC meeting of the US Federal Reserve were laced with caution and caveats. But basically it noted that the US economy is improving as is the jobs market and interestingly the Fed thought it a good time to release a statement about how it would normalise monetary policy, which is significant in itself.

Interest rates in the US mortgages

By Justin Pugsley, Markets Analyst MahiFX

Now that the end of quantitative easing – set for October – is taken as a given by the markets the Fed is now paving the way for higher interest rates, which is likely to happen in H2, 2015. It will be the first time US rates have been increased since June 2006, which will be a historic moment. The Fed is hoping that the better prepared the markets are for the event – the less disruption it will cause when it actually happens.

EUR/USD – how low can it go?

EURUSD September 2014 technical chart for currency analysis in the wake of US rate hikes

While the Fed is exiting, others are just getting started

Besides a tighter monetary policy bias, USD is supported by a number of other factors. The Bank of Japan is still doing quantitative easing, which could see USD/JPY take-out levels of 115-120 within the next six months.

The European Central Bank, meanwhile, is shifting closer to a much more lax monetary policy, which could take EUR/USD all the way down to 1.2000. Given the Eurozone’s structural problems defeating deflation tendencies and stimulating economic growth could require an epic amount of stimulus.

The other factor is that the US has benefited enormously from cheap energy due to fracking. It has supported consumer spending amid weak wage growth, has helped manufacturing and the trade balance. All USD positives.

However, it isn’t all rosy. One of the major concerns is the low rate of worker participation in the US labour market, currently only 62.8%, it was 66% in December 2007.   It’s important whether this is structural, possibly due to more retirees, or if it is cyclical and therefore has further room to expand.

If it is structural i.e. there aren’t going to be many more people entering the work force, then wage increases may not be that far behind and once unleashed could rise quickly. That could force the Fed into raising interest rates more quickly and higher than expected.   The other issue with keeping interest rates too low for too long is that it could fuel dangerous asset bubbles and at the moment those look more of threat than inflation.

However, the worrying aspect when reading into the FOMC comments is the uncertainty the Fed seems to portray over the outlook for the economy.   The best traders can do is match the Fed’s intentions with their own analysis of the economic data – because it appears that at the moment the Fed is not a lot wiser about economic conditions than the markets. That’s partly because many of the forward indicators it uses have been distorted by QE.

Justin Pugsley

Justin Pugsley

MahiFX is headed by David Cooney, former global co-head of currency options and e-FX trading at Barclays Capital and responsible for the award winning e-commerce platform BARX and Susan Cooney, former head of e-FX Institutional Sales in Europe for Barclays Capital. Operating as a market maker, MahiFX provides traders direct access to institutional level execution speeds and spreads through its proprietary-built fully automated pricing and risk management technology, lowering the cost of retail forex trading. MahiFX global operations are headquartered in Christchurch, New Zealand with offices in London, UK with development and support teams in both locations for 24 hour service. The company is regulated by The Australian Securities and Investments Commission (ASIC), Australia’s corporate, markets and financial services regulator. Article by Justin Pugsley, Markets Analyst MahiFX  Follow MahiFX on twitter and on facebook  Disclaimer: This material is considered a public relations communication for general information purposes and does not contain, and should not be construed as containing, investment advice or an investment recommendation, or an offer of or solicitation for any transactions in financial instruments. MahiFX makes no representation and assumes no liability as to the accuracy or completeness of the information provided. The use of MahiFX’s services must be based on your own research and advice, and no reliance should be placed on any information provided or comment made by any director, officer or employee of MahiFX. Any opinions expressed may be personal to the author, and may not reflect the opinions of MahiFX, and are subject to change without notice