U.S. Interest rate hike finally has "Lift-Off"

Yesterday, The U.S. Federal Reserve raised the fed funds rate by 0.25% to 0.25% – 0.50%. The zero interest rate policy had been in effect for 7 years, ever since the Fed slashed its key rate by 0.75% back on Dec. 16, 2008. The immediate reaction to the announcement saw a quick burst of USD strength taking USDCAD from 1.3780 up to 1.3847 – the highest level since 2004. The move was short-lived and the USD saw some broad-based weakness after the press conference taking USDCAD down to 1.3740 before rebounding towards 1.3780. Although Federal Reserve Chair Janet Yellen is confident in the U.S. economic outlook, she emphasized that subsequent rate hikes would be gradual and data dependent. Looking at the Fed “Dot Plot”  there are some changes from the previous meeting:

2016 = 1.375% unchanged

2017 = 2.375% down from 2.625%

2018 = 3.25% down from 3.375%

Longer run = 3.5% unchanged

The USD has been rising steadily over the past 2 years in anticipation of interest rate “lift-off”. The divergence in central bank policies is expected to be a shorter-term trend as other central banks have recently switched from a dovish to a neutral stance. It will only be a matter of time before global interest rates follow the Fed’s lead. For this reason alone, yesterday’s rate hike and subsequent rate hikes may already  be priced into the market. Significant further gains in the USD may be limited. A recent foreign exchange poll from the major Canadian banks suggest that the USDCAD rate will peak in Q1 2016 and then trend lower over the balance of the year.

A quick snapshot of where we’ve been and where we are today:

Dec. 2005

Bank of Canada overnight target rate was 3.25%

U.S. Fed funds rate was 4.25%

WTI oil was trading at $59/ barrel

USDCAD held a 1.1425 – 1.1750 range

Dec. 2015

Bank of Canada overnight target rate is 0.50%

U.S. Fed funds rate is 0.25% - 0.50%

WTI oil trading at $35/ barrel

USDCAD trading in a 1.3280 – 1.3971 range

Steve Brown

Senior Corporate FX Trader

stevebrown@vbce.ca