Fed Officials Stepped Up Rate Hike Talks Ahead of Blackout Period

Witawat (Ed) Wijaranakula, Ph.D.
Fri Sep 9, 2016

The U.S. dollar index, or DXY, a weighted index of the value of the U.S. dollar relative to a basket of six major currencies and practically the USD/EUR exchange rate, inched up 0.30% on Friday to close at 95.26, after the currency market was caught by surprise with the Fed's hawkish tone despite weak U.S. economic data. A number of Fed officials came out this week and expressed their opinions about the case for a rate hike, before the blackout period that begins the Tuesday of the week preceding a Federal Open Market Committee (FOMC) meeting and ends the Thursday following a meeting.

The DXY bounced off the 94.47 support on Thursday, following the European Central Bank’s (ECB) announcement that it kept key interest rates unchanged at 0%. The ECB move, by not announcing additional stimulus measures as growth and inflation in the eurozone continue to remain sluggish, appeared to disappoint financial markets. 

ECB President Mario Draghi’s concerns about inflation in the eurozone remain, as the core inflation rate, excluding food and energy, in August increased just 0.80% over the same month in the previous year, and the long-term trend is still down. Draghi insisted that the ECB stands ready to change its policy-stimulus program if needed. 

Draghi may also want to wait-and-see what the Fed will do with interest rates at the September FOMC meeting. A weak euro may not be his priority but it is positive for inflation, as it makes imported goods more expensive in the eurozone and exports become more competitive in countries like the U.S.

The EU directorate-general Eurostat confirmed on Tuesday that the eurozone second-quarter 2016 GDP expanded 1.6% over the same quarter last year, compared to 1.7% in the first-quarter 2016. The seasonally-adjusted unemployment rate (EA-19) remained at 10.1% in July, the lowest level in five years, while the labor force precipitation rate stood at 56.8%. 

Some Fed officials, including John Williams, president of the Federal Reserve Bank of San Francisco, have called for gradual interest rate hikes for various reasons besides economic. Williams said in his remarks to the Hayek Group on Tuesday that the U.S. economy was in "good shape" and called for rate increases, despite that inflation may rise to the Fed's 2% target in the next year or two.

Overall, U.S. economic growth is tepid compared to the eurozone economy, as in late August, the U.S. Bureau of Economic Analysis revised the U.S. second-quarter GDP (second estimate) 2016 to 1.1%, from 1.2% previously reported, while the first-quarter GDP grew just 0.8%. U.S. industrial production, accounting for about 12% of the GDP, dipped into recession in the first-quarter 2016, after the Fed raised its key interest rate by 0.25% at the December 2015 FOMC meeting. The U.S. manufacturing sector has been battered since the first-quarter 2015 by a strong dollar and weak global demand. 

The core PCE, excluding food and energy, the Federal Reserve primary inflation gauge, was 1.57% in July on year-on-year basis, down from a 1.59% increase in June and a 1.64% gain in May, according to the U.S. Bureau of Economic Analysis. In fact, the core PCE index has been running below the Fed’s target of 2% since the deep recession in 2007-2009, except for the first-quarter 2012, when the core PCE was at 2.09%. The core PCE could stay below 2% for years if the U.S. dollar index stays buoyant above the 92 level due to depressed commodity prices and cheap imports.

Although, in August, the U-3 and U-6 unemployment rates in the U.S. remained at 4.9% and 9.7%, respectively, the labor force participation rate stood at 62.8% as some 94.4 million Americans were not in the labor force. From the household survey, the number of persons who were not in the labor force but want a job now registered at 5.83 million, meaning the unemployment rate would be 8.6% if this group of persons was considered as unemployed. Hence, at maximum employment as defined by the Fed, the labor market might run into problems with a shortage of highly skilled workers but not with people who want a job.

Technically, a bearish head and shoulders chart pattern with a neckline at the 92 level has emerged in the DXY daily chart. In the event of a breakdown of the head and shoulders chart pattern, the DXY price objective is 85.35. The Fed officials’ hawkish speeches, however, should provide strong support for the U.S. dollar index.


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