Last Wednesday the open market committee of the FED raised the benchmark lending rate with 0.25% as widely expected. Still markets were disappointed as it was generally expected that the central bank would indicate an accelerated pace of rate hikes. Instead, just two more increases this year were projected. Those who expected a faster pace of rate hikes were either over-weighted USD’s or underweighted bonds. After the announcements traders unwound positions. The USD weakened and bonds rallied. The chart below illustrates how the 10-year and 2- year government bond yield declined following the rate announcements.

The EURO rallied against the DOLLAR from 1.06- area to 1.0740, as obviously declining US-yields caused interest rate differentials to narrow in favor of the EURO.

Source: Bloomberg

It is also interesting to see that just hours after the Fed’s decision, the Bank of Japan announced its policy: leaving interest rates unchanged at -0.1% for the short term and keep the 10 year stable at 0%. The central bank will further continue to grow the monetary base until inflation stabilizes around 2%. The BoJ added that additional stimulus, which currently includes bond purchases of USD 706 billion per year, including a possible rate cut of the short term or long term rate will be considered if necessary.

The same day China’s central bank (PBOC) raised some of the borrowing costs as economic growth is stable thereby halting further depreciation of its currency.

The Swiss National Bank finally kept its deposit rate at an historic low of -0.75%, while the target for the 3-month rate was unchanged at -1.25% to -0.25%. The SNB indicated that the CHF is “overvalued” and interventions on the FX-market will be considered. The negative interest rate makes Swiss investments less attractive and limits the currency appreciation.

There is an obvious divergence in monetary policy where the FED is tightening; the PBOC cautiously follows the FED while the BoJ, the SNB and also the ECB continue their monetary easing.

Courtesy RBC Royal Bank, Sales & Trading

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