On 12th July 2017, Janet Yellen – the Federal Reserve chair – delivered a testimony to Congress. This was to update politicians on the state of the US economy. And it was watched closely by traders across the globe for signs about potential changes in monetary policy. To help you understand what was said, I’ve written an article entitled: Analysing Yellen’s Testimony To Congress.
Why Is This Important?
Generally, a testimony from the Federal chair garners major attention. But this appearance by Yellen was particularly important, as it shed light on the plans for future interest rate rises.
As a Forex trader, you should know that interest rate changes have a profound effect on the value of a currency. Remember, higher interest rates encourages saving money. That’s why investors tend to shift their capital to countries with higher interest rates. Due to the laws of supply and demand, the currencies of those countries then appreciate in value.
The US is currently in a hiking cycle. This means the country is in a phase of increasing its interest rates. It’s a process which started in December 2016, when the Fed increased its interest rates from 0.25% to 0.5%. In March 2017, rates were hiked again from 0.5% to 0.75%. Furthermore, after these hikes, the Fed stated that another two could happen later in 2017.
Why Hike Interest Rates?
Since the financial crash of 2008, interest rates in the world’s major economies have been historically low. Why? Central banks wanted to kick start economic growth and job creation to address the global recession.
How do lower interest rates do this? Well, they make it easier for consumers and businesses to borrow money. This encourages consumers to spend more and businesses to invest in their workforce. Clearly, the net effect is economic growth.
This is the policy the Fed pursued since the financial crash to December 2016, while implementing a quantitative easing programme. The Obama administration also passed a stimulus package in 2009 in an effort to create jobs.
Because of these approaches, economic growth and job creation has built up momentum in recent years. But as economic growth speeds up, so does the rate of inflation (the increase in goods and services). Hiking interest rates is a means of tapering inflation. In December 2016, the Fed felt the US economy was strong enough to continue to grow with a slightly higher interest rate.
Another factor behind the decision may have been the incoming administration’s fiscal agenda. The then President-elect Trump had promised a $1 trillion dollar stimulus package to revamp US infrastructure. This is an inflationary fiscal policy.
Has Anything Changed?
During her testimony, Yellen surprised some market commentators with concerns about the current rate of inflation.
For five years, US inflation has been under the Fed’s target rate of 2%. At the moment, it currently stands at 1.4%. Yellen was pressed on the logic behind increasing interest rates when inflation was under its 2% target. In response, Yellen surmised that the Fed was open to adjusting its monetary policy. But only if it became clear that there was no upward pressure on inflation from the growing US economy. This video from the Financial Times shows Yellen’s comments.
Clearly, the Fed expect to alter its monetary policy plans if they think they need to boost inflation. This could mean slowing the hiking cycle. I think it’s too early to tell what the Fed will do. So the next set of US CPI and the Fed’s preferred means of inflation (Core PCE) takes on new significance. During Yellen’s testimony, the US Dollar Index fell to 87.98 (a drop of 0.3%).
Other Points Of Concern
During her testimony, Janet Yellen also commented on the US national debt ($19.9 trillion). She showed concern at the current plans for spending and taxation, highlighting that they will add to unsustainable levels of debt. The national debt is something that Forex traders should monitor closely. It’s an issue of contention with many Republicans. In fact, it led to a government shutdown in 2013. Should this happen again, expect downward pressure on the dollar.
Yellen also mentioned that she had not had a conversation with Trump about renewing her term as Federal Reserve chair (which ends in February 2018). In my opinion, it looks like Yellen will be replaced next year.
Prospects For The Dollar
At this moment in time, I believe the Fed will follow through with its planned rate hikes – even if the cycle slows slightly. But I’m certainly backing long-term strength for the US dollar.
However, there are a couple of caveats to this prediction.
The first is the difficulty the Trump administration is having in passing legislation through Congress and the Senate. From a fiscal point of view, the delay in passing legislation on spending and taxation plans could cause investors to lose confidence.
Another issue is Russia. At the time of writing, this issue is proving to be a constant distraction for The White House. Elements from the Trump campaign are under investigation for collusion with Russia during the US election.
It’s unclear where the Russia investigation will lead. But this obviously has the potential to damage the Trump presidency. As such, traders should follow this story closely.
Analysing Yellen’s Testimony To Congress
I hope you have found this article useful. If you have any questions, please leave them in the comments below. I’ll try to answer as many as I can.