There is a risk that the US dollar may rise on the Federal Open Market Committee’s (FOMC) FOMC minutes. As I detailed last week, the loss of corporate profits and poor global growth are two big factors why the FOMC is expected to increase the federal funds rate on Friday. This will likely send market reaction into a major correction.
To discuss the possible rise in the USD, we need to look at the national income statement. The Federal Reserve had greatly overstated the extent of US GDP growth in the last year.
As a result, they have told the markets that the Federal Funds Rate should remain the same and there is no need for fiscal stimulus.
Unfortunately, this is exactly what the FOMC will do as they lower the dollar. The dollar is in a fundamental support level. The US dollar peaked in January and has since started a recent decline. In order to prevent further declines in the US dollar, the FOMC needs to hike interest rates at its December meeting.
If there is a signal from the FOMC minutes that the committee expects to hike rates, then the US dollar may continue to appreciate in response to the central bank policy action. However, if the FOMC stays mum and remains on hold, the dollar should move up.
The FOMC is expected to raise the fed funds rate by fifty basis points on Friday. This could send the dollar higher or lower depending on how the market reacts.
In my prior articles, I discussed the FOMC’s history of moving with the market. I explained that if the FOMC hikes in the fed funds rate, the central bank increases short term treasury rates and increases in the US dollar’s strength against the Euro.
This can cause investors to hold their foreign currencies rather than sell their American currency. This can lead to a loss of capital for the investor. It is for this reason that the FOMC generally lowers interest rates during a tightening cycle.
On the other hand, if the FOMC cuts interest rates, this will send short-term treasury rates lower and the dollar may appreciate. However, if the FOMC cuts rates too low, the economy will suffer and it will only be seen as a tactical move and the market is likely to reverse its previous trend.
The key is that if the FOMC does lower its target for the fed funds rate, it should be done so gradually. When markets begin to trade more conservatively, it is time to raise the fed funds rate slowly and let markets determine when it is time to raise the federal funds rate.
In my analysis, the first quarter is the best time to increase the fed funds rate because the fed funds rate is already below its target and short term treasury rates are under pressure. However, if the FOMC hikes rates too quickly, it could create a panic and the market may reverse its previously achieved trend.
Of course, the risks involved with the FOMC action have me buying the stock market and selling bonds. That said, we are probably in for a minor correction and this correction may be short lived.
As a result, I still believe that the currency is undervalued. If I am correct, investors should not place all of their money in the markets.