In the past week, the U.S. Dollar has strengthened by about 2-2.5%. Now, we could attribute that rise to patriotic spillover from Veteran’s Day, but we know the real reason was the stronger than expected U.S. jobs data last Friday.

Against the EUR, the USD has reached a six-month high, as the short-term interest rate differential is at its highest level since 2007. The trajectory of interest rates in Europe and the U.S. is now moving in opposite directions. The European Central Bank is interested in further monetary easing, while the Fed is more likely to increase rates as early as December.

One benchmark to watch whether a December Fed rate hike will happen is the Fed Fund futures market. This reflects the market’s expectations of the future path of Fed Funds rate in a quantitative way. Just 10 days ago, the futures market was only giving a 40% chance of a December rate hike. After her hawkish remarks during Fed Chairman Yellen’s recent testimony before the House Financial Services Committee and especially after the stronger than expected US labor market report last week, this probability shot up close to 70%, giving the USD a boost.

Undoubtedly, many other factors beyond domestic economic figures affect exchange rates but part of the reason why people are paying more attention to the short-end of the futures curve right now may be a reflection that more people are in cash, as both equities and bonds have been quite unstable.  Any short term interest rate hike will easily shift money from one currency to another.

Some analysts have predicted that if the futures market doesn’t give a 70+% probability of a Fed rate hike before December, the Fed may fear acting.

My View:  The Fed’s decision will surely not be dictated by the futures market alone. But as we get closer to the December meeting, more US economic data and global events may cement the expectations. And as the probability moves closer to 100%, the USD should benefit, but if it moves the other way the USD won’t. Since the USD has moved in synch with the future market recently, it may be worthwhile watching this indicator. 

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