Dollar Gains as Fed Raises Interest-Rate Target From Record Low

Fed Raises Interest Rates, First Time in Nearly a Decade
  • U.S. currency swings between gains and losses after statement
  • Central bank plans `gradual' path for increases next year

The dollar climbed against the euro and yen after the Federal Reserve raised interest rates for the first time in almost a decade, adding to the allure of assets denominated in the U.S. currency as it ends an unprecedented period of near-zero rates.

The greenback climbed after swinging between gains and losses against its major counterparts as the Federal Open Market Committee said that the pace of subsequent increases will be “gradual” and in line with previous projections. The decision comes after months of signaling that the central bank was approaching liftoff.

"The Fed created some balance between expectation for higher rates in 2016 with a dovish overtone regarding the ‘gradual’ pace," said Minh Trang, a senior foreign exchange trader at Silicon Valley Bank in Santa Clara, California. "That’s why you’re not seeing a stronger rally on the greenback."

A gauge of the U.S. currency had risen almost 9 percent this year on expectations that the Fed would boost rates in contrast with central banks in Europe and Japan that are carrying out unprecedented stimulus. Hedge funds and other large speculators hold bullish dollar futures positions close to an all-time high.

The dollar gained 0.2 percent to $1.0912 against the euro as of 5 p.m. in New York, after falling as much as 0.7 percent. It added 0.4 percent to 122.21 yen.

The Bloomberg Dollar Spot Index, which tracks the currency versus 10 counterparts, was little changed at 1,229.75.

“From a currency standpoint, a lot of this was discounted in the market already," said Matthew Whitbread, a Boston-based investment manager at Baring Asset Management. “We’re not seeing the markets really convulse on this announcement; risk assets across the board remain pretty well behaved on the day which is nice to see so broadly speaking the market really priced this in.”

The Federal Open Market Committee unanimously voted to set the new target range for the federal funds rate at 0.25 percent to 0.5 percent, up from zero to 0.25 percent. Policy makers separately forecast an appropriate rate of 1.375 percent at the end of 2016, the same as September, implying four quarter-point increases in the target range next year, based on the median number from 17 officials.

“The committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run,” the FOMC said in a statement.

"The Fed’s finally aligned their words and actions -- the market is taking this in stride," G. Scott Clemons, chief investment strategist at Brown Brothers Harriman, said. "A lot of the Fed hike was priced into the currency market already."

While the currency has strengthened against most of its major peers this year, adding to an 11-percent climb in 2014, its ascent has been bumpy amid weaker-than-estimated U.S. economic data and a slowdown in China.

Yet some of the biggest banks trading in the $5.3-trillion-a-day currency market are predicting further gains for the greenback next year as the Fed tightens policy. The dollar may strengthen to parity with the euro in the second quarter, according to 16 of more than 60 analysts surveyed by Bloomberg.

When the Fed last raised interest rates in June 2006, the dollar traded at $1.2665 per euro. At the time, the price of oil was $73.52 a barrel and benchmark 10-year notes yielded 5.2 percent.

Bond Buying

The Fed began its extraordinary accommodation in 2008 by lowering rates to near zero to bolster economic growth. The dollar fell to record lows against the euro and yen amid a bailout of the U.S. banking system during a financial crisis that has rivaled the Great Depression in its depth and severity.

That year, the Fed also began its first foray into bond purchases, which tend to debase the currency. The central bank started with mortgages in November 2008, then adding Treasuries to the mix in March 2009.  In total, policy makers approved $4 trillion in bond purchases, with the Fed holding $4.5 trillion in assets on its balance sheet.

Inflation expectations have remained below what proved to be a high-water mark. In 2012, Fed officials formally began targeting an inflation rate of 2 percent, as measured by personal consumption expenditures, in an attempt to spur prices forward. 

The central bank’s trade-weighted dollar gauge reached a 12-year high on Dec. 11 as a rout in emerging markets propelled the greenback against the currencies of a broad swath of U.S. trading partners, including China and Mexico.

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