Shortly before the decision of the US Federal Reserve on monetary policy, the agenda is again over strengthening US dollar. A number of banks and analysts predict more expensive US currency in 2017. The US dollar recently hit its strongest level since 2003. However, at the end of 2015 also there were strong estimates for more expensive US currency in 2016, but the appetite for risk deteriorated in the first quarter. According to the economists, this time it is different and the main reasons are four – reborn industry, unemployment decrease, inflation growth and conservatism of Fed.
US and many global economies operate at higher speeds. In late 2015 the US industry was in recession, but in November the index of the Institute for supply management (ISM), which measures business activity in the sector reached 53 points, which is the highest figure this year. Moreover, stocks in the US fell and it seems that global trade is recovering, although this development is threatened by the new US administration headed by Donald Trump.
The unemployment, as well as the filed applications for unemployment benefits, are at a lower level today in comparison with the same period last year and the trend is even improving. The unemployment rate in the US was moving in both directions during the year, but in November recorded a sharp decline to 4.6%. So the wider measure of unemployment, which includes employees working reduced hours, turns out to be a good indicator of improvements in the labor market. This index (U6) remained unchanged over the last few months of 2015 and in the last two reports reported significant improvement.
The inflation expectations in the markets are rising due to higher commodity prices and forecasts for more fiscal stimulus after Trump takes the office. Hopes that more oil producers will comply with the agreement to lower yields (currently promoting price of the crude oil) can also support the expectations for inflation. Although the jump in bond yields caught the attention of investors, the growth in inflation expectations suggests that real interest rates have risen by much less than the nominal yields on government bonds. This means that the increase in interest rates has not yet reached a value that would hit the real economic activity or that would reduce the appetite for risky investments. The actual yields today are about 25 basis points lower than they were at the end of 2015, so there is still some leeway before rising yields become destabilizing to the market.
There is evidence that global growth is stabilizing and that the US economy is improving, which underpins the mandate of the Fed and is crucial for the continuation of flexible financial conditions. However, markets expect the Fed to act more slowly over the next 12 months than expected at the end of 2015. Because of the low expectations, more likely the Fed to justify them or surpass them, which will support the dollar. Morgan Stanley predicts six increases in US interest rates until the end of 2018, which is in line with the latest expectations of the central bank, but above market expectations of overnight index swaps.
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