A Rate Hike Is Imminent, No Matter What

November 2 2015

It looks like the Federal Reserve has put itself in an impossible situation. Yet again, the Fed left interest rates unchanged last Wednesday. And while that wasn't a surprise, the pressure is building up on the Fed's Open Market Committee. Coming December, they'll be more or less forced to raise interest rates, and the high officials are fully aware of it.

U.S. Central Bank Hints at December Rate Hike

Earlier I wrote that I was expecting an even stronger dollar. At the time of writing, the EUR/USD stood at 1.14. On Wednesday, after the Fed made its intentions clear on the upcoming rate hike, the EUR/USD dropped below 1.10.

Using information provided by futures markets, CME calculates the likelihood that the Fed will raise interest rates upcoming December. Earlier this month, it was estimated to be 26%. But since Wednesday, it has shot up to 50%!

Usually, the written statement following a meeting of the Open Market Committee doesn't involve more than some copy and paste work. But this time, a change caught my eye:

  • In determining how long it will be appropriate to maintain this target range (note: short-term interest rates)

Was changed to:

  • In determining whether it will be appropriate to raise the target range at its next meeting

rate hike odds for december 15-16 fomc meeting

The Fed Has Little Choice

We have now arrived at a point at which the Federal Reserve has to raise interest rates, simply to show that they are actually capable of doing so.

And they'll have to do so with the outlook on a weakening U.S. economy.

Mark the date! December 16th will be an important day. While preparing for Christmas will probably be the first thing on your mind, it could also be a violent market year-end to keep an eye on, with declining stock and commodity prices (including the gold price, but it mostly concerns the silver price and platinum price).

The Dutch Disease

In a world of freely floating exchange rates, a rate hike equals a stronger U.S. dollar. However, today's floating exchange rate system is inherently unstable.

This instability is also known as the Dutch disease, which is usually associated with natural gas and (the discovery of) commodities. But in fact, the Dutch disease is a more general phenomenon also experienced under a system of freely floating exchange rates. 

To state things briefly, I argue that speculation usually leads to more price stability, but, under floating exchange rates, will lead to violent (destabilizing) price fluctuations.

Or, as the billionaire George Sores tells us:

[F]loating exchange rates are prone to develop self-reinforcing trends that eventually carry them into far-from-equilibrium territory. The major currencies clearly show such patterns. Trends often persist for several years before they are reversed, causing wide and disruptive fluctuations.

We are in the middle of a so-called 'disruptive reversal'. And the complications of the Dutch disease are fully applicable to the U.S. economy and its foreign trading partners.

The current flight into the U.S. dollar has major consequences for the worldwide economy, and monetary policy of all central banks. And as long as this flight into the dollar continues, the dollar will strengthen. In turn, this has major consequences for the U.S. economy. Furthermore, it is one of the main causes of declining revenues and profits of U.S. businesses; a sign of an economic downturn.

The Gold Price Decline is Not Over Yet

For a moment, it looked like the gold price was about to make a breakthrough. It went as high as $1.190 per troy ounce. But, by now, it has fallen back to $1.140/oz. My expectation is that it will decline even more.

Meanwhile, the U.S. S&P 500 index is on its way to experience its biggest one-month increase ever. Likewise, stock prices may very well make one final push up.

Take-away: mark the date (December 16); a great excuse to avoid Christmas shopping, considering that the Federal Reserve may very well trigger enormous volatility on the markets.

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