Rise in interest rates
On Wednesday 14 December, the US Federal Reserve raised interest rates by another 25bps for the first time in a year, boosting the already strong US dollar.
The Federal Open Market Committee (FOMC) voted unanimously to raise the Federal Funds Rate to 0.5%-0.75%, after failing to move for the whole of 2016, despite originally indicating this year could see more than one interest rate hike.
Investors were so convinced the central bank would finally make a step to tighten monetary policy further that they poured money into US dollar ETPs ahead of the meeting. ETF Securities, for example, recorded inflows of $4.1m into its USD ETPs in the week before the FOMC meeting (the data covers the week to 9 December).
There remained some uncertainty in the market over the outlook for the coming year to be provided by the US central bank, with ETF Securities warning the market could be “overpricing the chances of the Fed raising its ‘dot plot’ for next year”.
However, the Fed surprised investors by raising its guidance for 2017 to three interest rate hikes, from the two previously expected, though chair Janet Yellen remained relatively dovish, saying the path to interest rate normalisation will still be slow and rates will remain well below long-term averages for some time to come.
Nevertheless, the US dollar soared to a 14-year high against a basket of currencies on the news, hitting $1.2546 against the pound and $1.0484 against the euro on Thursday. By Sunday, however, it was trading at $1.2431 against sterling, as the UK currency fell further when the Bank of England chose to keep rates on hold in its December meeting.
The question remains how long-lived this dollar strength will be, with some suggesting the greenback could take a breather following the rally. However, many commentators still expect strong dollar to be the story for the remainder of 2016 and beyond.
Deutsche Asset Management’s CIO Stefan Kreuzkamp is predicting the dollar will reach parity with the euro within 12 months – as the US currency strengthens, the euro remains under pressure from political instability across the eurozone, with a number of key elections coming up next year.
Bad news for emerging markets
Meanwhile, a strong dollar is bad news for emerging markets, which has already been reflected in investment flows. European ETF investors took €1.1bn out of Bond Emerging Markets Global ETFs in local currencies in November, according to data from Thomson Reuters Lipper. Emerging markets equities suffered some €900m of outflows, while hard currencies EM global bonds saw €600m of outflows.
This compares to strong inflows of €2.6bn into US equity ETFs, while global and European equities also took in €2bn and €1.2bn, respectively.