From Port Phillip Insider (AUS) – Call it what you like, but it all leads to the same thing: a currency war.
Movements in interest rates have a direct bearing on the value of a nation’s currency. That’s not to say the currency will always move as expected, but there is an indisputable relationship between interest rates and currencies.
That’s why last week’s statement from the US Federal Reserve, and the publication of the ‘Dots’ chart, caused the Aussie dollar to soar by two cents against the US dollar.
If you’re wondering what the ‘Dots’ chart is, we’ll show you here:
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This chart may look complex at first, but it’s simple.
The yellow dots are the predictions for the Fed Funds Target Rate of Federal Open Market Committee (FOMC) members. The green line pinpoints the median rate for those predictions.
Interestingly, the red line indicates where the market believes the Fed Funds rate will be for the corresponding period. As you can see, the median rate, according to the Fed, is for the Fed Funds rate to be at 3% by 2018.
But the market doesn’t believe it. Based on the prices for interest rate swaps, investors figure the rate will be somewhere around 1–1.25%.
That’s a big difference.
It’s another example of central bankers being out of touch with reality. The FOMC members are either grossly over-optimistic about the strength of the US economy, or they’re trying to use psychological mind-power to push the market that way.