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The Fed Finally Hiked Rates. Now what do we Watch for the Dollar?

Fundamental Forecast for the US Dollar: Bullish

- US Federal Reserve Hikes in most Telegraphed Policy Change of past Decade

- The Dollar was supposed to fall in December and didn’t. Does it rally in January?

- See what separates top traders from the rest in the Traits of Successful Traders Series

The US Federal Reserve finally raised interest rates in what was likely the most telegraphed monetary policy change in the last decade. Yet the Dollar finished somewhat lower all the same. Now what?

Volatility is likely to fall considerably into the final two weeks of 2015, and as such our focus for this “weekly” forecast will be on market price action through the beginning of the New Year. And in that sense it seems Dollar price action could be fairly straightforward—the narrow focus on the future of Fed interest rate policy will make the USD especially sensitive to key economic data releases and Fed speech.

In raising interest rates at their recent meeting, Fed officials likewise predicted that they would vote to increase rates by approximately 100 basis points further through 2016. This in itself is perhaps not especially surprising; it suggests that they would raise interest rates by 25 basis points once per quarter. Yet the fact that this is considerably above current market forecasts does raise eyebrows.

According to Fed Funds futures and Overnight Index Swaps, traders predict that the Fed will raise rates by approximately half as much as the Fed itself predicts for 2016. The difference is slightly less stark when compared in absolute terms: markets predict 50bps to the Fed’s 100bps. But in a world of near-zero and negative interest rates across other major global currencies, the difference between these estimates could make for considerable volatility in the New Year.

We’ll need to wait until January to get the next major economic data out of the US, and in the meantime it will be important to keep in mind that market liquidity is likely to remain low. Volatility remains unlikely into year-end, but illiquid conditions can make for exaggerated intraday price swings and do represent financial risk. - DR

--- Written by David Rodriguez, Quantitative Strategist for David specializes in automated trading strategies. Find out more about our automated sentiment-based strategies on DailyFX PLUS.

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