Key Fundamentals Impacting the U.S. Dollar
Federal Reserve Bank (Fed):
The U.S. Central Bank has full independence in setting monetary policy to achieve maximum non-inflationary growth. The Fed's chief policy signals are: open market operations, the Discount Rate and the Fed Funds rate.
Federal Open Market Committee (FOMC):
The FOMC is responsible for making decisions on monetary policy, including the crucial interest rate announcements it makes 8 times a year. The 12-member committee is made up of 7 members of the Board of Governors; the president of the Federal Reserve Bank of New York; while the remaining four seats carry one-year term each, in a rotating selection of the presidents of the 11 other Reserve Banks.
FOMC Voting Members in 2003
· Alan Greenspan, Board of Governors, Chairman
· Timothy Geithner, New York
· Ben Bernanke, Board of Governors
· Susan Schmidt Bies, Board of Governors
· Roger Ferguson, Board of Governors
· Edward Gramlich, Board of Governors
· Donald Kohn, Board of Governors
· Mark W. Olson, Board of Governors
· Robert McTeer, Dallas
· Anthony Santomero, Philadelphia
· Gary Stern, Minneapolis
· Alfred Broaddus, Richmond
· Michael Moscow, Chicago
· Jack Guynn, Atlanta
· Robert Parry, San Francisco
Sandra Pianalto, Cleveland
Thomas Hoenig, Kansas City
Cathy Minehan, Boston
William Poole, St. Louis
Fed Funds Rate: Clearly the most important interest rate. It is the rate that depositary institutions charge each other for overnight loans. The Fed announces changes in the Fed Funds rate when it wishes to send clear monetary policy signals. These announcements normally have large impact on all stock, bond and currency markets.
The interest rate at which the Fed charges commercial banks for emergency liquidity purposes. Although this is more of a symbolic rate, changes in it imply clear policy signals. The Discount Rate is almost always less than the Fed Funds Rate.
10-year Treasury Note:
Since isuance of the 30-year Treasury Bond was discontinued in October 2001, the 10-year Treasury note has become the benchmark, or the bellwether treasury instrument for long term interest rates. It is the most important indicator of markets expectations on inflation. Markets most commonly use the yield (rather than price) when referring to the level of the bond. As in all bonds, the yield on the 10-year treasury is inversely related to the price. There is no clear-cut relation between the long bond and the US dollar. But the following relation usually holds: A fall in the value of the bond (rise in the yield) due to inflationary concerns may pressure the dollar. These concerns could arise from strong economic data.
Nonetheless, as the supply of 30-year bonds began to shrink following the US Treasury's refunding operations (buy back its debt), the 30-year bond's role as a benchmark had gradually given way to its 10-year counterpart.
Depending on the stage of the economic cycle, strong economic data could have varying impacts on the dollar. In an environment where inflation is not a threat, strong economic data may boost the dollar. But at times when the threat of inflation (higher interest rates) is most urgent, strong data normally hurt the dollar, by means of the resulting sell-off in bonds.
Being a benchmark asset-class, the 10-year note is normally impacted by shifting capital flows triggered by global considerations. Financial/political turmoil in emerging markets could be a possible booster for US treasuries due to their safe nature, thereby, helping the dollar.