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posted on 28 December 2015

As The Fed Rate Hike Retreats Into The Background, The USD Follows Suit

Written by , Intertrader

The greenback has retreated 1.9% through November and December, but it remains 25% higher year-on-year by November 2015.

After the Fed Came the Pullback for the USD

When the Federal Reserve Bank moved to hike interest rates on Wednesday, December 16, few people could have anticipated the smorgasbord of results that came about. For starters, the Fed rate hike decision released significant pressure from the global markets, leading to sharp declines in the volatility index, the US Dollar Index and the overall performance of the USD in the international arena. While many analysts were expecting the double whammy effect on the euro, this simply did not come to pass. The euro was tapped to depreciate significantly against the greenback after Mario Draghi and the European Central Bank (ECB) implemented a series of monetary policy decisions to stabilise the European currency and increase the inflation rate.

Policy Measures

These measures included a 10-basis point drop in the deposit rate to -0.30% and a 6-month continuance of the asset repurchases program valued at €60 billion per month. But here is the clincher: The actions taken by the European Central Bank were less than what was forecast by analysts. An expectation of €75 billion per month for an additional 6 months was anticipated, and when lesser measures were taken by Mario Draghi, the euro rallied. It went as high as 1.10+ against the greenback, but as soon as the Fed rate hike was implemented a week ago, the dollar regained some ground and has since pulled back to 1.08+ to the euro.

It appears as if quantitative easing and quantitative tightening policies - however disparate they are - failed to put more daylight between the EUR and USD. Instead, the world's foremost authorities are expecting the European economy to grow by 1.8% per annum in 2016 and the US economy to grow between 2.25% and 2.5% over the same period. In other words, the economies are moving closer together in terms of actual performance.

How to Interpret the Volatility Index?

There are several indexes used by currency traders, equities traders and analysts to determine the pulse of the market. Two such measures are the volatility index (VIX) and the US Dollar Index. Both of these measures are important in the context of recent decisions by the Fed. If we draw our attention to the volatility index, some important points can be made. The current level of the volatility index is 17.42, and it has declined by as much as 6.84% recently. The numbers represented by this index are important in that they determine the fear factor - the anxiety in the markets.

The greater the uncertainty/volatility, the more likely traders, investors and analysts are to take the wrong actions. The 52-week range for the volatility index is 10.88 on the low end and 53.29 on the high end. The volatility index hit a high of 40.74 on 24 August 2015 and has since retraced to a low of approximately 14 before beginning its gradual ascent towards 24.59 on 11 December, and then retreating since the Fed decision. It takes into account the implied volatility of multiple strikes and it is based on a weighted average. Suffice it to say, we are seeing an exceptionally low level of volatility on the markets heading into Christmas and New Year.

How to interpret the US Dollar Index

In a similar fashion, the US dollar index has also retreated since the Fed rate decision. This index tracks the USD against 6 currencies, and it has moved lower in the days since the Fed decision. This is in agreement with the general sentiment expressed by currency traders on the markets which shows a 1.9% weakening of the USD since November, with more to follow. The next rate hike for the USD is forecast for April 2016, with a 51% likelihood of occurring. As it stands, the dollar bulls appear to be resting, and trading activity between now and the New Year is going to be exceptionally light, and this will reflect with the currency exchange rate of the USD against other currencies.

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