Dollar Strength Continues After Fed Promised to Continue Tightening – Introduction
The central bank plays an important role in any country. This is because it is given the responsibility of regulating the financial sector and governing the monetary policy. It ensures financial stability of any country. The central bank is called upon when a country’s inflation rises or when it falls. When it rises, the bank can reduce the amount of money in circulation and when inflation falls, it can increase supply by reducing the interest rates. For this reason, the central banks are watched closely by investors.
Last week, the Federal Reserve met and announced its monetary policy decision. The decision left interest rates unchanged at 2.25% as traders had expected. This news on its own did not move the market. What moved the market was the hawkish view of the Fed. The bank provided a forward guidance that showed that the bank was likely to continue tightening. This raised the chances of another rate hike in December open. This will be the fourth rate hike this year. The bank also guided to three more rate hikes in 2019.
After the financial crisis, the Federal Reserve decided to reduce interest rates. It did this to spur consumer spending and stabilize the economy. When interest rates fall, people tend to borrow money to spend. As they do this, they trigger inflation. A rising – but controlled – inflation is usually a good thing for the economy. The Fed’s target inflation rate is 2%. A falling inflation rate is not good because it tends to lead to increased unemployment rate. This is because companies’ profits fall when the prices of products fall. As a result, they lay off people so that they can maintain their margins. This year, the rate of inflation has become slightly stable at 2%.
The Fed’s decision to continue raising rates is a bit controversial. This is because of a number of reasons. First, while the US economy is doing well, there are concerns that the growth will slow down in the coming year. In fact, the third quarter GDP growth was 3.5%, which was lower than the 4.2% in the second quarter.
Second, the increasing tightening is happening at a time when the yield curve is threatening to reverse. The yield curve is the spread between the short-term government bonds and the long-term bonds. Longer-term bonds usually attract a higher yield because of the risk aspect. When the yields on the short term bonds increase more than the longer-term bonds, the yield curve is said to be inverting. When the yield curve inverts, it mostly leads to a recession. This happens as investors move from stocks to the shorter term government bonds that yield well. Therefore, there are chances that the yield curve will flatten or invert as long as the Fed continues to tighten.
Third, there is a concern about the urgency of the rate hikes. After the crisis, the major central banks decided to ease monetary policy. While the Fed has continued to tighten, other banks have largely ignored the tightening policy. They have not shown any sign that they will increase. In fact, the US president has continued to criticize the Fed for continuing to tighten.
Dollar Strength Continues After Fed Promised to Continue Tightening – UsefulTips