Higher rates and the US Dollar: what it means

• Posted by Greg Harmon
• on March 12th, 2015

Two of the most talked about sectors in the financial markets lately are the US Dollar and interest rates. The US Dollar woke up in July and started higher. Since then it has gained over 20%. That is a big move for the greenback so it is no wonder you aunt Esther wants to know how to get involved.

Interest rates have been talked about for over a year, but for the opposite reason. While all of Wall Street has expected interest rates to go up they have not really moved that much. The rhetoric is heating up now though as the Federal Reserve Governors are ramping up their mentions of a need to start raising rates sooner rather than later.

Personally I find this latter aspect bizarre given the Federal Reverse dual mandate and the seeming dismissal of the inflation goal. Not only is inflation not heating up but it is no where to be found. Why slow an economy that is exhibiting no inflationary tendencies? But hey, I’m not a Fed Governor nor even a high priced Wall Street economist. So I will just stick to the facts of the situation.

The two stories are now merging and that is what interests me. With the discussion of a rising Dollar being a de facto tightening on the economy, what will happen when the Fed does raise interest rates? The theory goes that higher rates on our bonds will attract foreign money, a demand for Dollars, that makes the Dollar even stronger and further tightens the noose around the neck of the economy. But does that actually happen?

The chart above shows the US Dollar Index (plotted as a red line) against the 13 week T-bill rate going back 30 years. This T-bill is the shortest Treasury funding instrument and therefore the most sensitive to moves interest rates. Over this 30 year period it seems the US Dollar has moved in a much narrower range than interest rates. From a very long scale it might even look like interest rates have no impact on the US Dollar.

But with the lack of volatility in the Dollar Index perhaps the long term comparison is not completely fair. Lets look at each of the 4 periods where rates were rising during this span, from April 1988 to April 1989, January 1994 to December 1994, April 1999 to November 2000, and May 2004 to August 2006.

April 1988 to April 1989

In the first period, interest rates rose by over 50% over the 12 month period. The US Dollar did rise as well, drifting up about 8% during the timeframe. It is notable that the Dollar continued to drift higher after the Fed stropped raising interest rates.

January 1994 to December 1994

In the rate rise period that took place all of 1994 and early into 1995. short term T-Bill rates rose almost 100%. But during this tightening phase the US Dollar actually fell by almost 10%. Again the move that started with the tightening continued in the US Dollar after the tightening was over.

April 1999 to November 2000

The rate hikes that took place into the new millennium saw short term T-Bill rates rise about 45%. And over this timeframe the US Dollar also rose. It was up about 16%. This time the US Dollar did not continue its trend after the rate hikes were done.

May 2004 to August 2006

Finally the last time the Federal Reserve raised interest rates started in May 2004. Yes almost 11 years ago. It lasted until August 2006 and over that time short term T-Bill rates rose 450%. And what happened to the US Dollar? Flat as a pancake before, during and after. Some would argue this was the perfect interest rate management implementation.

There are some interesting takeaways from this review. First over 30 years, short term T-Bill interest rates were rising 4 times. During this span those periods accounted for a total of less than 6 years, only 19% of the time. Each of the 4 rate hike periods was different but all lasted at least 12 months. There were also no single token rate hikes. More importantly to this analysis is that the reaction from the US Dollar was different each time.

It is entirely possible that once interest rates start to rise that it may impact the US Dollar. But there is no clear correlation between the two from 30 years of rate hike history. The only thing you can do is watch what happens and follow along.

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