The Significant Impact of the Fed Rate Increase on the Dollar

The Significant Impact of the Fed Rate Increase on the Dollar

The Significant Impact of the Fed Rate Increase on the Dollar – Some people are watching the Fed because they expect a rate hike to trigger the Dollar rally. Unfortunately, some basic-level analysis indicates that the dollar is not as closely related to the Fed’s rate hike cycle.

Kathleen Brooks of in a note dated August 17, 2015 looks back at the previous cycles of Fed rate hikes in 1987, 1994, 1999, and 2004, and here are the results:

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1987: The dollar falls in the first few months after a rate hike.

1994: The dollar moved sideways, before moving in a mild uptrend.

1999: The dollar continues its mild uptrend that started before the Fed started raising interest rates.

2004: The dollar falls as the Fed begins its rate hike cycle.

You can see from the depiction on the chart below, which shows the Dollar index and rising US interest rates. The chart below has been normalized to show how the two move together.

So, what does that mean for traders?

Do not rely on the Fed to determine the direction of the movement of the Dollar in the coming months.

When the Fed starts raising interest rates, the Dollar tends to follow the previous dominant trend.

There is no direct relationship between the Fed raising interest rates and the fall of the dollar. When a weak dollar coincides with the Fed’s rate hike cycle, the weakness has (usually) been going on for some time.

Therefore, Brooks at that time projected a calm reaction to a potential Fed rate hike in the next few months.

So, the question this time is, where will the dollar move if the Fed rate goes up?

If the Fed does raise rates in September (which is still unlikely given the projections the Fed Funds futures markets are pricing in), history tells us not to expect too much from the dollar’s reaction. However, since the Dollar has been rallying in an uptrend towards this event since mid-2014, there is a possibility that the Dollar will rally in line with the Fed rate hike cycle, although analysis suggests that this may not be affected too much by whether the Fed does raise or not.

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