Fed Hikes In A Bear Market, What’s Next For USD?

The much anticipated Fed interest rate decision finally is behind us, and no one was disappointed. The currency traders especially, considering that besides the USD knee-jerk reaction, the market is heavily influenced by the end of year flows.

With most of the U.S. stocks in the bearish territory (i.e., the price falling after death crosses on daily timeframes), many voices argued that the Fed wouldn’t hike. History told us that never a hike happened under such market conditions.

And yet the Fed raised rates. Again.

To the surprise of many, the press conference was pretty hawkish too. Powell, the Fed’s Chairman, even stating that the QT (Quantitative Tightening – the process during which the Fed shrinks the balance sheet) will continue at a constant pace.

In other words, while the rest of the world barely raise rates or even keeps them in negative territory (e.g., Switzerland, Japan, Eurozone), the Fed runs a double tightening program. The by-the-book interpretation is that the USD will become scarcer, USD debtors having a tough time finding it on the market. Hence, a hawkish message for the dollar.

The currency market surely reacted as such. Trading algorithms sent the USD higher across the board, with many USD pairs traveling over a big figure on the announcement, with the USD/CAD being one of the leaders.

On the press conference that followed, the Fed hinted at two more rate hikes to come next year, further widening the gap between the interest rate in the United States and the rest of the free world.

It is said that by raising the interest rates, a central bank prepares for the next recession. Many voices argue that if the rates go too far, the central bank ends up creating a recession, as banks will prefer to park their excess reserves in overnight deposits at the central bank.

In other words, there’s a thin line between the appropriate rate level and the moment when a recession begins. Apparently, the U.S. stock market took a hit on the announcement.

After the Asian session saw the market consolidating the move, the end of year flows started to pour in. Christmas and the New Year are known for creating a trading environment ideal for algo-trading, with many strategic traders squaring the positions for the end of the year.

Such conditions make room for unusual market moves, often considered irrational or illogic. As such, it is not a surprise that the EUR/USD erased the entire Fed move lower, and even made a new high.

The actual effect of yesterday’s Fed’s decision is to be seen starting with 2019. As for the rest of this year, look for the market to move chaotically, as traders already have their eyes on the Christmas holidays.

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