Published On: Wed, Mar 25th, 2015

U.S. Federal Reserve’s decision to change interest rates to affect the dollars power agains the euro

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For the last six months, it seemed like the dollar could only go up. But if the Federal Reserve has its way, that might be over now.

It was a simple story. The U.S. economy was doing well enough that it looked like it would start raising interest rates soon, and the rest of the world was slowing down enough that it was cutting them. That meant investors could make more money in the United States than anywhere else, so that’s where they moved it, and, in the process, pushed up the value of the dollar — 14 percent since last summer. But now the Fed is saying it might not hike rates as early — or, more importantly, as often — as markets had assumed. And suddenly what seemed like a one-way bet on an even stronger dollar is unraveling a little.

Now the Fed sent a slightly confusing message at its meeting last week. It said it wouldn’t be “patient” about raising rates anymore — meaning it could start as soon as June — but also, in so many words, that rates would probably be lower at the end of the year than it had thought before. In other words, it wasn’t promising to keep rates at zero for much longer, but it was predicting that rates would stay near zero for longer than previously expected. Why? Well, a big part of it was how much the dollar has gone up already. That makes it harder for U.S. companies to sell exports overseas or compete against imports at home, both of which hurt growth. So, reading between the lines, the Fed was saying that the dollar had gone up about as much as it wanted it to right now. It’s not going to raise rates until the greenback cools off and the economy heats up again.

Markets listened. OK, that might be a generous way of putting it. A more accurate one would be that markets freaked out, then reversed themselves, then reversed a lot of that, too. The euro had been falling, falling, falling, all the way down to a 12-year low of $1.05, because the European Central Bank was starting to buy bonds with newly printed money and the Fed looked like it was about to start raising rates. It seemed like a sure thing — and, who knows, it still might be — that looser money in Europe and tighter money in the U.S. would keep sending the euro down and the dollar up. Deutsche Bank went so far as to forecast that the euro would fall to $0.90 by the end of 2016. But that’s become much less of a thing, let alone a sure one, after the Fed said that, on second thought, it probably wouldn’t raise rates all that much anytime soon.

Everyone who’d been betting that the euro was taking a one-way trip down suddenly had to buy euros to make sure they didn’t lose too much money now that it’s coming back up. And that only made it rise even more, which made them buy even more, and so on, and so on. That’s called a short squeeze, and it’s why the euro shot up 4 percent in a single night.

But what one over-reaction gives, another one takes away. By the morning, this panic euro buying had given way to not-quite-as-panicked selling that left the dollar right where it was before the Fed said it might keep the punchbowl out awhile longer. But then the cycle continued. Upon further, or maybe actual, consideration, markets decided that even though the Fed really does want to raise rates, it really won’t — so the dollar dove again against the euro. Indeed, markets think there’s only an 11 percent chance now that the Fed hikes rates at its June meeting, down from 18 percent just a few days ago.

Reality, in other words, is catching up to the dollar. The irony is that the dollar had been going up because the recovery had sped up enough that it looked like the Fed would have to start normalizing policy sooner rather than later.

But now the stronger dollar has hurt the recovery enough that it looks like the Fed will have to stick with the new normal of zero interest rates for at least a little, and maybe a lot, longer.

Source: http://thenews.mx/

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