How the value of the U.S. dollar can effect rates
October 18, 2009 by admin
The value of the U.S. dollar is one of the most closely followed currencies in the world and has a tremendous impact on the day to day economy as well as impacting future inflation changes. The recent rally in the U.S. stock market has garnered a tremendous amount of attention in the media, as the DOW rallied past 10,000 for the first time this year last week. During the recent rally on Wall Street, the stock market has gained over 600 pts, our roughly 7% in the month of October alone. This move up in equities has been steadily losing value. The dollar index closed at $75.83 on Friday last week, marking its lowest closing price of 2009 and lowest level that it has closed at in the past twelve months.
The continued deterioration of the dollar has significant impact on a number of areas in the economy. The price of a barrel of oil, which is priced of the U.S. dollar continues to move higher, following the inverse action of the currency instrument. The latest slide with the dollar comes at a time when oil prices have surged to their highest levels of he year, surpassing $77 per barrel in the past week. Oil prices remain one of the few areas of the economy that carries inflationary risk. The rapid increase in oil, has industry experts suggesting oil could once again reach triple digits in the next twelve months. The fallout from higher oil prices leads to inflation pricing changes on bonds. This effect moves investors to request a higher upfront premium for purchasing these financial instruments, which directly increases the rates to consumers. Rising interest rates are almost inevitable as the economy begins to recover and the Fed transitions their support of the mortgage backed security market to private investors. What the Fed and the balance of the economy should be concerned about is the external factors that could escalate the challenge of keeping rates near their current levels during this transition. The fallout from the decline in the dollar could have a ripple effect that challenges the economy to recover due to higher rates.
One area of the market that has not been dragged down by the market move is the perception that the U.S. is accumulating too much debt to attract foreign investors into bonds. This theory sent interest rates to their highest levels back in June when investors began to worry that the one trillion dollar deficit may be a cause of concern that would prevent foreign entities from purchasing Treasury securities. To date, the demand for securities continues to increase, a movement that has positively impacted long term interest rates. Bond yields are one of the key factors behind the pricing of mortgage backed loan securities. As bond yields move higher, mortgage rates tend to move up as investors purchasing Treasuries tend to follow similar trading cycles for mortgage backed bonds. Lower yields help to bring lower rates, as the market witnessed in early October, as the stock market dropped for a brief period of time.