Which Way Does The Federal Reserve Bank Go In 2016?

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While it is foolhardy to assume anything about the future course of 2016, the fundamentals are in place for what appears to be a year of strong gains and consistent performance for the world’s #1 economy – the US. With China in disarray, global demand in tatters, and crude oil oversupply dogging the markets, we can expect American strength to take pole position in a presidential election year.

Currency analysts and economists are expecting a 5% – 10% appreciation of the USD against the EUR this year, and a strong appreciation against the Japanese yen towards the 125 mark. These forecasts are part of a broader global trend of dollar strength, emerging market currency weakness, and multi-year lows for commodity prices. The Federal Reserve Bank FOMC is slated to meet on January 26 / 27 to discuss policy vis-a-vis interest-rate hikes. Analysts are predicting that the US will move to increase interest rates a total of 4 times in 2016 so that the overall federal funds rate will be in excess of 1% by the end of the year.

What does a higher federal funds rate mean for the USD and the global economy?

Every time the Fed is preparing to meet to discuss interest-rate hikes, market participants will display anxiety and speculative conduct in their trading activity on equities markets. The major averages tend to sell off as a rule in anticipation of a rate hike. The reasons for this are as follows:

If the US dollar is expected to appreciate owing to an interest-rate hike, US exports will become relatively more expensive to foreign companies and this will lead to a decline in sales activity, revenues and profitability. Also, rate hikes mean that the cost of borrowed money for US companies listed on major averages becomes more expensive and this leads to declines in dividend payouts, profitability as well as increasing prices.

If the US dollar is expected to appreciate, emerging market currencies will likewise depreciate. This means that the revenue streams of countries like Russia, China, India, South Africa, Venezuela, Brazil, Turkey and others will dry up and that the central banks of those countries will be depleting their foreign currency resources just to stabilize the exchange rates of their own currencies. In other words they will attempt to sell dollars from their forex reserves to cause a depreciation of the USD and an equal but opposite appreciation of their currencies. However that is unlikely to weaken the US dollar overall and will only result in balance of payments problems for emerging market countries.