With many of the questions much of the headlines are posing along with questions we are receiving from investors, we felt it timely to post a multipart series on the US dollar.
In order to keep this simple, it can get complex very quickly, we are going to focus on the main reasons for currency movement, in our opinion.
Currency fluctuations, in our opinion, are the result of interest rates. Interest rates are not the only determinate, but, in our opinion, interest rates drive the majority of the currency movement.
Interest rates, compared to other world interest rates, are one of the main drivers for currency fluctuation. (The carry trade, a topic for another discussion, creates much of the currency movement, again, in our opinion.)
Ok, so assuming you agree with the interest rate discussion, let’s compare the goals of two monetary governing bodies, EU and US.
From the Bank of England’s Website, it’s two core purposes: http://www.bankofengland.co.uk/about/corepurposes/index.htm
“Core Purposes – Monetary Stability: Price stability and monetary policy
The first objective of any central bank is to safeguard the value of the currency in terms of what it will purchase at home and in terms of other currencies. Monetary policy is directed to achieving this objective and to providing a framework for non-inflationary economic growth. As in most other developed countries, monetary policy operates in the UK mainly through influencing the price of money, in other words the interest rate.
The Bank’s price stability objective is made explicit in the present monetary policy framework. It has two main elements: an annual inflation target set each year by the Government and a commitment to an open and accountable policy-making regime.
Setting monetary policy – deciding on the level of short-term interest rates necessary to meet the Government’s inflation target – is the responsibility of the Bank. In May 1997 the Government gave the Bank operational independence to set monetary policy by deciding the short-term level of interest rates to meet the Government’s stated inflation target – currently 2%
Core Purposes – Financial Stability
The Bank of England has played a key role in maintaining the stability of the United Kingdom’s financial system for 300 years and it is now a core function of most central banks. A sound and stable financial system is important in its own right and vital to the efficient conduct of monetary policy.
Since 1997, the Bank of England has had responsibility for the stability of the financial system as a whole, while the Financial Services Authority (FSA) supervises individual banks and other financial organisations including recognised financial exchanges such as the London Stock Exchange.”
Now, from the U.S. FOMC website: http://www.federalreserve.gov/pf/pf.htm
“The Federal Reserve sets the nation’s monetary policy to promote the objectives of maximum employment, stable prices, and moderate long-term interest rates.”
As you can see there are a distinct difference in policy from the two governments, leading to dramatically different interest rate decisions.
Greater interest rate discussion in next part of the series.
JK
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John Kvale
Donald Capone
Taking the Punch Bowl Away-Fed DISCOUNT Rate Increased
Yesterday while at a Dr’s appointment, at around 3:30 pm, my cell phone dinged letting me know there was “Breaking News.” After reading that the Fed had raised the DISCOUNT rate, I immediately called the office to confirm the story, finding myself surprised, puzzled, and in a bit of disbelief.
Fed's Punch Bowl
Post Dr’s appointment, all good, and back at the office, I was able to confirm that the Fed had raised the DISCOUNT rate, to .75, or in Wall Street lingo 75 basis points (A basis point equals one tenth of a percent). DISCOUNT in all caps, is to bring your attention to the fact that this rate is not the more common Fed Funds Rate, but rather the rate banks can borrow from the Fed for short term lending, often times a last resort measure for banks needing quick capital. (Please click on DISCOUNT for a link to the FOMC official definition.)
Why my surprise?
We had been told rates would eventually need to be raised, but assured Fed Funds Rates will stay low for “an extended period” of time. Maybe the surprise was the delivery; a Thursday, non-Fed Meeting, after the close of markets, or maybe it was just a subtle belief rates would stay low for a longer period of time. The punch bowl is being pulled from the table, and now it is the beginning of a time for the US Economy to take hold on it’s own. In our Q 1 2010 digital Newsletter (Page 3) we stated the markets would be choppy as the hand off from stimulus, to holding our own began, we re-iterate this fact today.
What are the immediate results?
The first reaction will most likely be GASP! The US Dollar may rally, gold, and commodities (oil) down, market indexes will probably fall from trigger happy traders (overseas markets are doing this currently as well as market futures this am) and the headlines will fly.
A Good Thing! The Bigger Picture
Beyond the surface of first reaction, raising of rates, even if only the DISCOUNT rate, is a good event, and represents the Fed’s confidence in our US Economic strength. While the Punch Bowl may be getting tugged away, this is a good event, in our opinion, and may eventually be seen in this light!
Have a Good Day and Weekend!
JK
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Posted in Interest Rates, Market Comments
Tagged Interest Rates