Observation on the USD and Fed Funds Rates

Last week, I was having a conversation with one of my friends, @Vulgi about a research piece that was written by Nordea bank. The research showed how historically the USD would not rally just as the Fed would raise rates. I took it upon myself to look and see if that was the case or not.

As you can see in this chart, since 1970 this is the EFFR (Effective Fed Funds Rate) and the USD overlayed:

4-8-14EFFRUSD

 

The vertical lines are  when we started a rate hike cycle (Red) and  when the USD rally followed (Green). What I noticed is that the USD (in most instances) rallied quite some time after the Fed actually hiked rates.

The “Taper is not tightening” TV expert monologue may actually be quite true in today’s market. And frankly, even when the Fed (sometime in 2015) decides to hike rates, it may also be true that the USD may not rally immediately following any monetary policy tightening from the FOMC.

One function of the USD that is true at the moment, and has been for quite some time, is that the USD is the reserve currency of choice. Which means, during prolonged periods of risk aversion the USD tends to be the beneficiary.

4-8-14EffectiveFedFundsRateUSDSPX

 

The USD does have a unique role as the reserve currency of choice for most (for now until there is a better alternative). What you will notice about the chart above, when the stock market moves lower, the USD is usually already in demand, especially in 2000 and 2008. If the Stock market does turn lower in the next couple of months, the USD could benefit from risk aversion flows, and if the FOMC is still hell bent on raising rates at that point, the USD rally could continue.

So, before you get too comfortable with shorting the USD, do take note we are in the “apex” of a long term wedge which make it increasingly difficult to trade.

4-8-14DXY

 

Also, keep in mind the SPX may be at the upper end, or top, of an up sloping channel of the last 5 years.

4-8-14ES

 

One last thought. Steve “Sully” S also said “this ain’t your Daddy’s FOMC” which is very true. This isn’t your Daddy’s market or monetary policy he has ever seen.

 

 

Blake Morrow

Chief Currency Strategist, Wizetrade

Disclaimer: I am pretty sure within the next 72 hours I will buy and sell the USD in some way shape or form.

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