In today’s issue, we talk about Fed’s interest rate hikes, how they affect the dollar, and what we think your trading strategy should be in this market.
Tad DeVan is a Senior Forex Analyst for Market Traders Institute and host of the Ignite Trading Room. Ignite Trading Room is FREE to join for active SmartTrader users.
Jerome Powell’s statements will have all the market focus come December 15, 2022.
It will be the Fed’s rate hike decision day and market participants will want to know if the Fed will raise rates by 0.50 percentage point or 0.75 percentage point – or not at all.
The Fed’s action could and likely will have a large effect on how billions of dollars across the world get invested. Especially in the Forex market, where USD pairs could see humongous volume and volatility.
So, let’s understand what’s behind these rate hikes, how they affect the dollar, and how you can learn to target potentially winning trades out of the resulting volatility.
Here we go…
Hike or Less Hike?
That’s the question. And to answer that question, let’s have a look at what the Fed has been doing lately.
The Federal Open Market Committee (FOMC), which decides the course of the U.S. monetary policy, has already delivered four consecutive 75 basis point or 0.75 percentage point rate hikes.
We’ve not seen rates this high or hikes at this pace in decades. Many pundits are likening Jerome Powell to Volcker, who fought inflation as Fed Chair from 1979 to 1987 with historically high interest rates.
The logic is simple: Prices are high because there is excess cash in the system versus the amount of goods to purchase. By increasing the cost of debt, and eliminating money created through home buying or car purchases, the Fed can greatly lower the money supply, and hopefully prices.
Less money with the bank = less money borrowed by the people. Less borrowed money leads to less spending and brings down prices by keeping the demand-supply balance in check. The prices stabilize and inflation cools. All in all, it’s one of the ways the Fed can control inflation and attempt to save the economy from running into a recession.
The last inflation reading in the U.S. came in at 7.7% for October. The Fed wants to bring it all the way down to 2%. So, it is trying to reduce inflation through what may be its most hawkish monetary campaign since the 1980s. And that explains the outsized 75 basis point hikes we’ve been seeing lately.
The Cost of Rate Hikes
Now, it’s important to understand that rate hikes are not all goody-goody. They influence borrowing costs for all kinds of consumer loan products.
Higher rates mean you’re paying more for credit cards, mortgages, auto loans, etc. And they can also lead the economy to recession where people don’t have the money to catch up with rising prices or repay their loans.
Here’s what the UN Conference on Trade and Development warned of the ramifications that the interest rate hikes could have globally…
In a decade of ultra-low interest rates, central banks consistently fell short of inflation targets and failed to generate healthier economic growth. Any belief that they will be able to bring down prices by relying on higher interest rates without generating a recession is an imprudent gamble.
The International Monetary Fund (IMF) has also pressed for no further Fed hikes for similar reasons.
So, if the Fed gets too aggressive, it can also risk cooling the economy too much.
Here’s how all of this can move the dollar…
Rate Hikes and the U.S. Dollar
One of the key fundamental concepts of Forex trading is understanding that inflation will affect interest rates, and interest rate expectations will affect foreign exchange rates.
Higher Inflation = Higher Interest Rates = Stronger Currency
This is because the less dollars in circulation, the more demand for them than the supply, and this can help the USD appreciate in value against other currencies.
This is evident from what we’ve been seeing in the last couple of months. As the CPI started to move higher, the USD has been in an uptrend.
If the Fed keeps hiking rates as they claim, USD strength is likely.
On the other hand, if they surprise the markets with lower than expected hikes, the USD could witness weakness.
In other words, a 0.75 percentage point hike in the December meeting could push the dollar higher. And a 0.50 percentage point rate hike could drag it lower vis-a-vis other currencies.
But again, things aren’t as simple in today’s intertwined global economy. We also need to focus on how other major currencies are moving. And for that, let’s look at what the good old Sterling and the Bank of England (BoE) is doing.
The U.K. economy doesn’t look in a good shape today with rampant inflation, stagnant growth, and rising energy costs.
So even if the Fed slows down, the BoE might mostly keep up with its oversized rate hikes in the U.K. and that could again keep the USD rally in check against the GBP.
All in all, there are a lot of moving parts here. And it remains to be seen how the Fed plans to move ahead in its December monetary policy meeting.
So, how can one trade this potential volatility?
Our top analysts are keeping a close eye on all the developments from this space. As things stand today, they are noticing a potentially exciting pattern playing out in a few USD setups.
You can know more and trade them LIVE with our elite traders in our upcoming webinar by clicking HERE.
Apart from that, remember that the increased market movement may lure you to take fast action. And we believe it’s important that you have a solid trading strategy in place, focus on your downside risks and manage them with the right asset allocation.
These are the cornerstones of a successful trading strategy. And we will continue to keep up with them in our trading rooms.
If you want more such trading strategies and market insights, check out the Analyst On Demand Trading Room.
Every week, within the trading room, Tad will take you through real market conditions and help teach you the keys to being a consistent trader across the board. Just spend a little time there and we believe you could see great results for yourself.
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