Courtesy of Shane Oliver of AMP Capital comes this simple yet effective chart that largely explains why the Australian dollar surged back above the US75 cent level earlier today.
Every second monetary policy meeting the US Federal Reserve’s Federal Open Market Committee (FOMC) offers updated economic forecasts, along with member forecasts for the projected path for the Fed funds rate in the years ahead.
There’s 17 members on the FOMC, and the chart below tracks the median member forecast of where the Fed funds rate will sit at the end of each calendar year.
As it demonstrates, the median expectation dropped significantly during the committee’s March policy meeting, particularly for 2016.
In December 2015 – the meeting where the FOMC raised interest rates for the first time in nearly a decade – the median expectation was that four 25 basis point interest rate hikes would occur over the course of 2016. Fast forward three months and that expectation has fallen to just two 25bp hikes being delivered in 2016.
While currencies are moved by a multitude of factors, yield differentials play an important role in determining capital flows.
Generally, but not always, the higher the yield the more attractive a currency is compared to others. While the Fed still indicates that further rate increases will arrive this year, the halving of rate hike expectations has diminished the appeal of the US dollar.
That, along with dovish language in the FOMC’s March policy statement and updated economic projections surrounding economic growth and core inflation, weakened the US dollar and underpinned the Australian dollar’s gains.