Fed raises interest rates by 0.25% – What now for the US dollar?

Yesterday evening, as expected, the Federal Reserve raised its base rate by 0.25%. This has moved the US interest rate within a range of 2-2.25%.

Overnight actions mark the bank’s eighth rate rise since 2015, continuing its policy of gradual rate rises. Now investors are looking for clues about how high the Fed might go or signs its pace could accelerate. Many analysts expect they will raise at least once more this year, with December historically being a month in which the Fed will act.

In the accompanying statement Fed Chair Jerome Powell  said Wednesday’s rate rise reflected the Fed’s confidence in the US economy, describing it as a “particularly bright moment” – US GDP grew at an annual pace of more than 4% in the second quarter of 2018, and the unemployment rate continues to hover below 4% – near historic lows.

Fed officials are showing their confidence in the US economy predicting it will grow by 3.1% this year, faster than their forecast of 2.8% in March.

What does this mean for the US dollar?

Historically if a country or zone raises interest rates you will often see a significant swing in the favour of the respective currency. This is because with a higher base interest rate it makes a currency more attractive for investors due to the higher yield it offers. As a result demand for that currency picks up and hence so to does its value.

We have seen a slight rally for the dollar but only 0.3% – what does this suggest? This suggests that the move by the Fed was expected and therefore had already been heavily priced into the market. This also means it is highly likely that future rate hikes are also priced in. For this reason I do not expect any significant rallies for the US dollar in the coming weeks and months. I believe it has now found its level, and I could actually see the GBP/USD price correcting towards 1.35.

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