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dollar bills sinking under water
Adam Morehouse

Fed Rate Hike Could Sink US Dollar

by Adam Morehouse | Dun & Bradstreet Editor

August 24, 2015 | No Comments »

dollar bills sinking under waterFew would argue that the US economy is in worse shape today than it was immediately after the global financial crisis. The labor market has firmed up, businesses are recording lower delinquency rates on commercial loans, and overall US business performance is more positive.

Improvement in these key metrics will likely prompt the Federal Reserve to adjust monetary policy when it meets in September 2015. Monetary policy makers will likely vote to increase the Federal Funds Rate for the first time this decade, moving overall policy from a very accommodative environment toward a more restrictive one.

How global currencies will react to this change remains to be seen. But if history is any indication, the US dollar could weaken, to the delight of exporters.

Currencies Are Sensitive

Each country’s currency is very sensitive and can fluctuate dramatically on a day-to-day basis. Major turning points in currencies can come from changes in both domestic and international policy.

In recent years, with increased globalization, international policy has become even more important in determining cross-country currency appreciation or depreciation.

How a currency is valued can help in assessing whether a country’s economy is improving or deteriorating.

For example, the US dollar has strengthened considerably against its peers. Since July 2014 the real trade-weighted value of the US dollar has risen nearly 20% when compared to other major currencies.

The dollar’s rapid rise has caused fits for US exporters as domestically manufactured goods become less competitive globally. This is a comparative disadvantage of a rapidly appreciating currency environment.

Many analysts are calling for a further appreciation of the US dollar as soon as the Fed begins to lift rates, but, based on past trends, the dollar may actually depreciate after the first rate rise.

A Walk Down Memory Lane

Since the 1980s there have been four occasions when the US Federal Open Market Committee began to raise the Federal Funds Rate in an attempt to steer the US from an accommodative environment toward a more restrictive one.

On three out of four of those occasions, the dollar actually fell 3%-11% against all other major currencies immediately following the rate hike. The exception was in March 1983, when the dollar appreciated by 4%.

While each case since 1980 is unique, one possible explanation of this phenomenon can be linked to the anticipation of a rate hike versus the actual reality of a rate hike.

Currencies are traded in the open market, and, much like a commodity, the market will ultimately dictate the value. Could it be that currency traders already anticipated the rate hike coming in 2015, sending the dollar higher in 2014 only to have it reverse after the initial hike? Perhaps, but only time will tell.

Another look at historical data suggests, with the exception of 1983 again, the time frame immediately before an initial liftoff was when the US dollar was strengthening against major currencies. This is similar to what’s been happening to the dollar during the current time period.

History could very well repeat itself in the coming month. Each time period faces its own fundamental and technical differences regarding the currency market. While the dollar might appreciate further, the scenario of a weakening currency should remain in the realm of possibilities. That should be good news for US exporters.

Adam Morehouse is a Macro Analytic Consultant on D&B’s Global Data, Insight & Analytics team. He covers parts of the Asia Pacific region as a contributor to D&B Macro Market/Country Insight Products. He also contributes to D&B’s monthly economic tracker, adding both commentary and analysis. Adam holds a BBA in finance from James Madison University in Harrisonburg, Virginia, and an MBA in financial management from Pace University in New York City.

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