Dollar's Post-Fed Rate Increase Slump Shows History Is Repeating

When it comes to the dollar’s slump this year, history is repeating itself.

The greenback has fallen 4.2 percent against the euro this year and it’s likely to keep plunging until at least the end of the quarter, according to SEB AB, Sweden’s fourth largest lender. That’s because the U.S. currency tends to weaken during the months soon after the Federal Reserve commences raising interest rates, as the central bank did in December.

“We really don’t see any positive driver for the dollar right now," Richard Falkenhall, a currency strategist at SEB, said by phone from Stockholm. "t’s really hard to come up with a story where you could expect the dollar to recover."

Strategists have lowered their outlooks for the currency, while hedge funds all-but abandoned net bullish bets this year after Fed Chair Janet Yellen signaled the central bank would act “cautiously” as it looks to raise rates. That’s capped a 20 percent surge during the past two years on expectations that the Fed would tighten monetary policy in contrast to easing by its biggest counterparts in Japan and Europe.

The Bloomberg Dollar Spot Index, which tracks the U.S. currency against 10 major peers, rose 0.2 percent as of 11:33 a.m. in New York, after falling 0.6 percent Tuesday to the lowest closing level since June 22. The U.S. currency was at $1.1327 against the euro.

Fed Watch

The Fed raised its target for the federal funds rate to a range of 0.25 to 0.5 percent in December, the first increase since 2006. Futures are pricing in a 55 percent likelihood of a rate increase by the Fed’s December meeting, based on the assumption that the effective fed funds rate will trade at the middle of the new Federal Open Market Committee target range after the next increase.

SEB raised its one-month euro-dollar estimate to $1.15, and predicted the exchange rate will rise to $1.16 in the second quarter. It forecast the dollar will recover in the second half of the year to trade below $1.10 by year-end.

"Maybe we could start to flirt with the idea the Fed could tighten again this year, and then we expect a recovery for the dollar," Falkenhall said.

The dollar fell 9.3 percent in the six months following 2004’s first rate increase, even as the Fed tightened another 1 percentage point, according to the Intercontinental Exchange Inc.’s U.S. Dollar Index, which tracks the currency against six major peers. The pattern holds for 1994, when the measure slumped 6.9 percent, and for 1999, when it lost 1 percent, as the introduction of the euro added to uncertainty that supported dollar strength.

“The environment and economy is completely different than what it was in 2004 or 1994,” Falkenhall said. “But you still have the same path when it comes to euro-dollar around the Fed hike.”