U.S. unit falls in Asia as Fed rate hikes seen as gradual

The conventional wisdom emphasizes lower borrowing costs of low interest rates that promote investment, but tends to overlook the fact that interest rate manipulation often leads to the wrong types of investment, causing events like the dot-com bubble in the 1990s and the housing bubble of the 2000s. However, it would appear that market participants are now questioning whether the positivity was justified. In 1973, the Federal Reserve lifted rates so quickly – 15 times in eight months – after Organisation of the Petroleum Exporting Countries slapped an oil embargo on the United States that the S&P 500 index fell 20 per cent over the next 12 months. The index is up 2.9% on the week so far.

“It is this U.S. dollar weakness and ongoing swoon in commodity prices that provides a jarring counterpoint to the gains seen in Asian equities of late”. The dollar’s weakness despite stronger signs of an impending rate hike in the USA indicated that investors have already expected the rate increase next month, Mizuho Bank said in a commentary.

Investors reacted by increasing the odds for a rate increase next month to 72 per cent, from 64 percent on Tuesday, based on interest rate futures prices.

This does call into question whether the recent strong rally in Dollars is a tad overdone.

Since the middle of 2014, the U.S. dollar has been strengthening, on the back of solid USA economic growth and building expectations that the US Fed will start lifting interest rates. There are outliers such as geopolitical risk and a European Central Bank stimulus measure for market makers to contend with, so mitigating investors’ currency risks is a real option to consider.

Benchmark 10-year Treasury prices rose 7/32 for a yield of 2.2465 percent, while the price for the 30-year note rose 26/32 for a yield of 3.0016 per cent.

Still, slower China growth will continue to put downward pressure on metals and other commodity prices, although the outlook for oil prices is less certain because richer economies tend to consume more oil per person, putting potential upward pressure on oil prices.

Worries about a hike have also been tempered by previous comments from the bank that any increase would be gradual.

With the odds of a 2015 interest rate take-off from the Fed now heightened further the Dollars can nevertheless expect to strengthen over the coming days. “Today there was the interesting news that the South Africans have raised their interest rate to deal with the possibility that the Fed will do that”. The CSRC said earlier this month that the IPO of 28 companies will be allowed to proceed by the end of the year, after they were suspended in a broader move to stabilise the local equity markets.

Last week, Cleveland Fed President Loretta Mester said the time to hike rates is “quickly approaching” and the Fed should not delay for fear of an adverse market reaction or uncertainty over how much the USA economy can grow without generating high levels of inflation. A few profit taking activity may ensue ahead of the weekend.

The discount rate is set by each of the regional Federal Reserves subject to the review of the Board of Governors.