For the U.S. dollar, 2016 was all about if/when the Fed will raise rates, and for the Fed, as always, their outlook and decisions were dependent on the data.
So, before checking out Greenback’s price action, let’s take a quick look at a few headline metrics to see how the U.S. economy developed throughout the year.
When looking at the monthly percent change, inflation growth continued to trend higher throughout 2016 from the early 2015 negative reads in consumer prices, producer prices, and the Fed’s preferred inflation measurement, the Personal Consumption Expenditures Index.
The Unemployment Rate hit a low of 4.6% in 2016, pretty much the pre-Financial Crisis levels, while the net monthly change in Non-Farm Payrolls continued to stay above the Fed’s +100K threshold level to sustain the current unemployment rate (with exception to a relatively weak read in May).
Gross Domestic Product growth accelerated throughout 2016 after a steady deceleration in growth through 2015, going from a 0.80% annualized read in the first quarter to a 3.5% annualized read in the third quarter.
The Ebb and Flow of Rate Hike Expectations
We can see from the data above that the U.S.’s economic situation started out with no strong argument for a follow-up to December 2015 tightening anytime at the beginning of 2016.
This was confirmed throughout the first quarter FOMC meetings where the Fed highlighted slow GDP in Q4 2015 and low inflation expectations in the January meeting, tightening financial conditions and slowing China fears in the February meeting, which lead to a downgrade in U.S. economic growth for 2016 in the March meeting.
But by the end of the second quarter of 2016, domestic economic conditions improved enough to where we saw a couple of FOMC members calling for a hike at the April and May meetings, but still no interest rate hike by the time we got through the June meeting.
This was likely due to hiccups in the May employment and business investment data, as well as situations outside of the U.S. that worried the Fed throughout the first half of 2016, including the Chinese Equity meltdown, the impending Brexit vote, the fall in oil prices, etc. (check out “A Monthly Review of 2016’s Trading Themes” to see all of the 2016 themes that sparked global risk aversion sentiment).
Still, no rate hike through the third quarter despite the continued broad improvement in U.S. data, once again likely due to exogenous factors (i.e., Brexit, Italian Banking & China concerns), mixing up the biases among Fed members.
But by the fourth quarter, while the economic numbers weren’t gangbuster reads in growth or inflation, it looks like they were good enough for the Federal Reserve to think that a near-zero interest rate policy is no longer appropriate.
So, the Fed raised the target Federal Funds rate in December as expected, but what wasn’t expected was the Fed surprising market players with a more hawkish rate hike outlook for 2017 and 2018.
U.S. Dollar Price Action
In the chart below of the U.S. Dollar Index, we can see how the economic data and policy expectations drove price action, and as a bonus for all of the Dollar bulls out there, the “surprise” election of Donald Trump to be the next President of the United States turned out to be the icing on the cake, propelling the Buck higher on the potential for fiscal stimulus from the incoming administration.
The U.S. Dollar Index looks like it will end 2016 on a high note, up over 4.00% as of Friday’s close, and up over 11% since the May 2nd low:
And there were more wins than losses for the Buck against the major currencies:
What’s next for the Greenback in 2017?
With more rate hikes ahead expected from the FOMC, it’s easy to say it’s “to the moon” for the U.S. dollar, but several questions should be pondered before mortgaging the farm to buy some dollars: Are the potential additional rate hikes already priced in?
How will a rising dollar affect U.S. trade and the global economy?
Will Trump’s proposed stimulus plans come into effect or were they just campaign pipe dreams?