The FOMC statement for 2014 has been a major talking point in the Forex market. In fact, the FOMC has gained unprecedented attention since the expectation is that the monthly asset purchases program will be reduced. It is expected to shed light on the interest rates, the monthly asset purchases and the overall outlook of the U.S. economy.
The reduction would lead to major changes within the market conditions and would inspire confidence in the U.S. assets. It has also been predicted that the Fed would further reduce its stimulus by $10 billion. The prediction alone has allowed currency pairs such as the USD/CAD to attain a four-year high.
This brings the attention to the increase in interest rates and how it would impact the currency market within foreign exchange, also influencing banking trends in the longer run.
Interest rate and currency pairs
The major talking point in the markets revolves around future interest rate expectations. They have gained such importance that they are taking precedence over the general headline rate.
The general progress is that currencies with low interest rates (like the U.S. Dollar) are expected to raise interest over 2014. This would lead to the rise of the U.S. dollar versus other currencies that already have a high interest rate, and no further increase in sight (like the South African Rand).
The predictive analysis leads to an investor preference of moving capital from lower yielding currencies/assets towards higher yielding currencies/assets. The widely awaited FOMC statement has led to more attention being focused towards the future interest rates rather than the present one.
At this juncture, investors within the currency market can learn from what happened in 2005. At that point, the U.K. GBP was already at higher interest rates with 250 basis points. When the U.S. announced rising rates, GBP fell by 8% narrowing down the difference to 25 basis points. Similar currency pair fluctuation is expected this year.
This is where the emerging currencies within the status quo may find themselves in a quandry. This can already be seen with the South African rand falling down 2% against the U.S. dollar just in time for the FOMC statement.
The markets within the Eurozone have already taken measures, such as borrowing from the European Central Bank, to keep the impact of monetary policy easing within control.
The current situation also means a great deal for the market funds. Just a day back, the auction of floating rate treasuries was announced: it will provide diversification options to investors. The auction has already sold off $15bn of floating rate notes, indicating a strong market demand.
Currency market accounts and impact
With the market being conducive for money market accounts, investors are looking at a lucrative 2014. By utilizing a money market savings graph, a comparison of rates can be made. This allows a selection of not only the best interest rates, but also long term investment options. With the way the market is shaping up, such tools and accounts can be used in ‘laddering’ approaches to increase profits.
A study done on the post-recession currency market changes and interest rate fluctuation has highlighted the usage of a ‘monetary policy triangle’ to better analyze the market. Investors can make use of three factors including short term policy rate, exchange rate and long term interest on government bonds to understand which currency would be their best bet.
The concept of monetary policy helps to cater to the behavior of the institutions in the post-recession era. The speculative hike in interest rates is also a derivative of long term policy measures arising as a result of the financial crisis.
The present money market is in an ideal position for countries to use for the growth of their reserves. This can be understood from an analysis done on six industrialized economies (U.S., Japan, Switzerland, U.K and the Eurozone). The result is that reserve increases within the regions was mostly based on market fluctuations in exchange rates (mostly between the U.S. dollar and Euro), and also through capital gains via investment portfolios.
With the liquidity injections provided by the Fed (quantitative easing program) beginning to subside, rates are expected to rise. This would impact the currency market in a multidimensional manner. Investors should keep currency pair based growth in check and also notice how individual governments are responding to the change. Additionally, the selection of appropriate currency market accounts will lead to higher profits within the year.
Written by Jane Brown