Why Two More Fed Rate Hikes Are Certain In 2018

A strong US economy and the risk of higher inflation make further rate hikes this year very likely.
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In this article, we’ll explain why two further interest rate hikes by the Federal Reserve in 2018 are a near certainty.

Specifically, we’ll explore the current economic strength of the US. In addition, we’ll explain why higher interest rates are necessary.

Furthermore, we’ll explain what higher interest rates mean for the US dollar.

After you’ve read this article, you will understand the Federal Reserve’s current monetary policy. You’ll also know how this could affect your trading.

Here’s what the article covers:

  • US Economic Strength
  • The Fed’s Future Monetary Policy
  • Impact On US Dollar

US Economic Strength

In July 2018, US GDP hit 4.1% for the first time since 2014 (as reported by NPR).

Make no mistake, this is an excellent reading for the US. The American economy is very healthy. Business confidence is high. Unemployment is also close to a 50 year low.

All good news, right?

Pretty much. But economies that experience fast growth need to ensure they don’t ‘overheat’.

This overheating comes in the form of inflation – which is the annual rate at which the costs of goods and services increase.

Now, most modern economies have a 2% inflation target. Due to a consistent period of strong economic growth, the US has recently hit that target, as reported by The Financial Times.

If strong economic growth continues, inflation could increase further and overshoot the 2% target.

Controlling Inflation

Clearly, the Federal Reserve will not let inflation get too high. Keeping inflation at a sustainable level is one of its priorities.

So how is inflation controlled? It’s through monetary policy – a mechanism controlled by central banks.

The US central bank is the Federal Reserve. At the time of writing, it is in a period of tightening monetary policy. In other words, it wants to reduce the flow of money in the US economy.

It is doing this by increasing its benchmark interest rate. This is the cost charged to commercial banks for borrowing money from the Federal Reserve.

The intention here is simple.

By increasing the cost of borrowing, it makes it more expensive for commercial banks to lend to the public and businesses. Usually, this results in commercial banks reducing the amounts they lend.

The Fed’s Future Monetary Policy

The Federal Reserve’s current hiking cycle started in 2015. Since that time there have been seven interest rate hikes.

The current US benchmark interest rate is set between the 1.75% – 2% range.

At the time of writing, investors forecast a 90% chance of another 0.25% rate hike in September. Another rate hike is also forecast for December.

Impact On US Dollar

Traditionally, interest rate hikes act to strengthen native currencies.

The logic behind this is simple. Higher interest rates are a magnet for foreign direct investment. Typically, these investors want to hold their capital in currencies with higher interest rates. By doing so, they can make their capital generate higher returns.

Another consequence of higher interest rates is a tightening of a country’s money supply.

Following the laws of supply and demand, a squeeze on supply in the face of high demand causes a currency’s price to increase.

This is what is likely to happen to the US dollar.

However, this effect could be tapered by an important fundamental event. Namely, global trade tariffs.

As reported by The New York Times, the Trump administration is attempting to renegotiate trade deals with various global partners. These partners include Canada, Mexico and the European Union.

A tactic deployed by the Trump administration was to introduce aggressive US import tariffs on steel and aluminium. This has triggered a series of retaliatory tariffs, raising fears of a global trade war.

These fears have weighed on the US dollar. In fact, as documented by Reuters, tariffs have already applied downward pressure on the US dollar in July 2018.

Traders should monitor global trade developments closely in the coming months. Signs of discord will weigh on the US dollar and could counteract dollar strength from future interest rate hikes.

Why Two More Fed Rate Hikes Are Certain

In this article, we’ve explained why two further rate hikes from the Federal Reserve are almost certain in 2018.

Particularly, we’ve analysed the current strength of the US economy. Plus, we’ve explained why higher interest rates are necessary to keep inflation in check.

In addition, we’ve highlighted how strong economic growth and further interest rates hikes will act to strengthen the US dollar. However, we’ve also referenced how trade tariffs could cause volatility.

If you have a topic that you’d like us to explain, then please type your suggestions in the comments section below.

Please also feel free to ask any further questions too. We read every comment and do our best to respond to your ideas.

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