Dollar’s Surge Goes From Road Block to All-Clear Signal for Fed

  • Trade-weighted U.S. currency index approaches 12-year high
  • Financial markets remain stable, giving Fed comfort to hike

Is a Fed Rate Hike in December Definite?

What a difference a year makes.

When the dollar surged around this time last year, the stock market tumbled and oil prices fell into a tailspin, forcing Federal Reserve officials to scale back plans for the pace of interest-rate increases. Yet if anything, the currency’s strength the last couple months may encourage policy makers to tighten this time around.

"Financial conditions are still a lot easier than the first half of the year, and so far equity markets are performing relatively well," said Vassili Serebriakov, a foreign-exchange strategist at Credit Agricole CIB in New York. "The dollar should give them comfort that they can tighten without upsetting the market."

The trade-weighted broad dollar index, which tracks the U.S. currency versus 26 of the country’s biggest trading partners, has rallied 3.1 percent since its lows in mid-August. At the same time, the S&P 500 Index has slipped just 2.1 percent, crude has risen 5.5 percent, and a Bloomberg gauge of stress in financial markets remains largely little changed.

In contrast, the dollar gauge rallied 6.9 percent from mid-October 2015 to a 12-year high in January, contributing to an 8 percent slump in the S&P 500 index and a 43 percent slide in crude. While that didn’t stop the Fed from raising interest rates last December, it did ultimately cause policy makers to scale back expectations for rate hikes in 2016, from four to just one now.

While all 76 economists surveyed by Bloomberg don’t expect the Federal Open Market Committee to raise rates at its Nov. 1-2 meeting, six days before the U.S. presidential election, traders are pricing in a 69 percent probability of tighter Fed policy by year-end.

A strong dollar crimps overseas profits for U.S. companies, and weakens demand for oil, which is priced in the greenback. Fed officials have repeatedly warned of the deflationary risks of currency appreciation in the past, with chair Janet Yellen saying last year the dollar posed a “notable drag” on growth.

The Bloomberg Dollar Spot Index, which measures the U.S. currency’s performance against a basket of 10 major counterparts, rose 0.1 percent, the fourth week of gains and marking its longest winning streak since May. The gauge is up 2.2 percent this month.

The dollar may potentially "appreciate to a point where it has a negative impact on U.S. growth and inflation forecasts, but we are not there, not even close," said Richard Franulovich, chief currency strategist for the northern hemisphere at Westpac Banking Corp. in New York. "The Fed next week will probably make a signal that they are considering hiking in December."

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