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
