FOMC Raises Rates, Potentially Leading to Higher Dollar Exchange Value

The Federal Open Market Committee (FOMC) raised the federal funds rate target by 25 basis points, setting in place a firmer path to raise rates three times this year.

By raising rates in March, the FOMC steers clear of the complications to raising rates later that an unforeseen event, like a surprise French election, could bring, said Wells Fargo Chief Economist John Silvia.

The FOMC anticipates minimal changes to real GDP growth and inflation in the near term. “Meanwhile, in our view, the FOMC’s full employment target has been more or less met. One of the three FOMC policy pillars is that policy should look forward,” he said. “We expect the FOMC to work on this pillar as an improving economy pushes inflation toward the Fed’s two percent goal.”

On a global scale, the U.S. rates act as a benchmark for global investors “… as changes in U.S. rates alter yield spreads between sovereign debt returns as well as defining exchange rate risk between countries,” he said. “With out-of-sync economic cycles, the actual and expected interest rate/growth differentials for the U.S. support the case for the dollar’s increase in value over the last six months as well as a further increase over the next six months.”

Elsewhere around the world, central banks like the European Central Bank and the Bank of Japan aren’t in a position to raise rates, so actions by the Federal Reserve won’t be followed, leading to a higher exchange value for the dollar, Wells analysts said. This in turn will promote financial capital outflows. “China is in a more difficult situation since a stronger dollar would increase bilateral trade imbalances and incentivize further capital outflows—difficult results in today’s context,” Silvia said.

– Nicholas Stern, senior editor

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