The Federal Reserve Bank, and it’s FOMC (Federal Open Market Committee), will begin unwinding a $4.5 trillion balance sheet later in 2017. This has far-reaching implications for the US economy, notably the USD. During the global financial crisis, the Fed built up an impressive balance sheet through its QE program. Otherwise known as quantitative easing, this dovish measure of propping up the economy involved flooding markets with USD by buying up bonds and financial assets. Along with reduced interest rates, the US enjoyed an economic boom with accelerated velocity flows of money through the economy to help stimulate economic growth.
Since 2012, the US economy has steadily improved. Currently, the Dow Jones Industrial Average (DJIA) is trading around 22,000, the S&P 500 index is trading at 2,464.65, and the NASDAQ Composite Index is trading at 6,333.01. Viewed in isolation, these numbers may not mean much to an unassuming observer. However, the year to date return of the Dow Jones Industrial Average is 11.32%, and the 1-year return is 21.06%. The S&P 500 index has a year to date return of 10.08%, and a 1-year return of 14.89%. The NASDAQ Composite Index has been performing equally well with a year to date return of 17.65%, and a 1-year return of 21.88%. Many of these indices have enjoyed record levels of trading, owing to a weaker USD.
Why a Weaker USD Helps Listed Companies
The strength of a currency has a direct impact on trading activity. We have already seen how the Brexit saga affected the GBP, and levels of trading on the FTSE 100 index. A weak GBP bodes well for the FTSE 100 index since 70% of the companies listed on that index generate their revenues abroad. When these profits are repatriated back to the UK, they are worth more. For this reason, there is an inverse relationship between the GBP and the FTSE 100 index. There is another reason why currencies affect markets: exports. If a country’s currency depreciates relative to other currencies, it becomes more attractive in terms of its export potential. This raises the revenues of exporting companies.
In 2017 the US dollar index has depreciated by 8.34%. This is significant enough to affect the export potential of US companies. As the USD weakens, so US manufactured goods and services become relatively more attractive to foreign buyers. This can also help to propel trading activity on US bourses. The current trading level of the DXY is 93.85. Over the past 5 days, the index has appreciated by 0.21%, but it is down 0.80% over 1 month, and 4.43% lower over 3 months. Recent tensions between North Korea and the US have rattled currency traders, and sent them scurrying for safe-haven currencies such as the JPY, and commodities like gold. Perhaps the strongest driver of trading activity for the USD is the Fed.
The Fed sets interest rates, notably the federal funds rate. On June 15, 2017, the FFR increased by 25-basis points in the region of 1.00% – 1.25%. The Fed is bent on rising interest rates, and unwinding its $4.5 trillion balance sheet. This has a positive effect on the USD, in that it increases demand for dollars. Foreign currencies will be sold and dollars purchased as this policy grinds into action. For people looking for lines of credit, now is a good time to sign on the dotted line, before the Fed pulls the trigger once again.
Rising Rates and Loan Applications in the US
The CME FedWatch Tool does not foresee any strong possibility of a rate hike on Wednesday, 20 September 2017. The current possibility is just 1.4% of a 25-basis point hike. On Wednesday, 1 November 2017, there is an increased likelihood of a rate hike at 7.2%. If this takes place, it’ll raise the federal funds rate in the region of 1.25% – 1.50%. Moving to the final Fed meeting of the year on Wednesday, 13 December 2017, things look markedly different. The probability of a 25-basis point rate hike is 49.2%, and the likelihood of rates remaining at the current level (1.00% – 1.25%) is 47.2%.
Given these projections for the federal funds rate, borrowers have at least three months grace to lock in relatively low interest rates before the Fed acts. Recall that the Fed is seeking an increase in the inflation rate (towards the 2% objective) and an improved overall economic status. Applications for credit continue to pour in, with banks and other financial institutions indicating steady volumes. Increases in the number of bad credit loans have been reported among bank and non-bank lenders. Current interest rate levels are such that it is better to lock in a low rate for mortgages, auto loans and personal loans now, and this bodes well for long-term returns.
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