There’s “no doubt” that the Fed will raise its benchmark short-term interest rate to 4.0% at its November 1 FOMC meeting from the current 3.75%, wrote Asha Bangalore, a Northern Trust economist, in a research note on Friday. Mr. Market concurs, based on the November 2005 Fed funds futures contract, which is priced in anticipation of 4.0%, as of today’s close. The momentum won’t stop there, the futures market also predicts. Drawing on the current price of the March 2006 contract, even higher rates await beyond the next FOMC meeting next month.

If fear of flying is the standard response for some as they ponder of world of higher rates, relief seems to capture the emotion elsewhere in the financial universe. The U.S. Dollar Index in particular is all too happy to hear that the price of money is on the march. Indeed, the greenback today continues to rebound after last Thursday’s dramatic 1.3% stumble. Since then, the Dollar Index has recouped its latest stumble, and then some.
Thanks go in part to the Federal Reserve, the new best friend of forex traders. “The reason the dollar is staying strong is because markets have continued to price in more Fed tightening,” Daniel Katzive, a currency strategist in Stamford, Connecticut at UBS AG, tells Bloomberg News.
Adding to the momentum for the buck’s new-found strength was today’s release of the minutes from the Fed’s last interest rate-policy meeting in September. Talk of higher interest rates is almost as potent as the actual event, and the central bank is making full use of the verbal tool these days. “Participants’ concerns about inflation prospects generally had increased over the intermeeting period,” the minutes advised. “The surge in energy prices, in particular, was boosting overall inflation, and some of that increase would probably pass through for a time into core prices.”
It didn’t hurt the dollar’s bullish cause today with new that political troubles may rise anew in the largest national economy that claims the euro as legal tender. Reports that Angela Merkel will be Germany’s next chancellor added to the skepticism that surrounds Europe of late. Merkel’s ascent came with the heavy price of compromise among the various political parties that agreed to vote for her (Germany’s being a parliamentary system of government). Historic though her advance is (she’s the first woman to head the government), some critics charge that the “grand coalition” that lends political life support will sanction precious little economic reform efforts going forward. That’s something less than good news for a country, and a continent in desperate need of economic restructuring. Or so the prevailing wisdom asserts, based on the euro’s sharp decline today.
“The dollar’s gains are pretty much broad-based, with losses being led by the euro,” David Mozina, head of New York foreign exchange strategy at Lehman Brothers in New York, told Reuters. “The belief last week that things are going to be pretty good in Germany is now starting to be wound back, given that the conditions that Merkel had to agree to become chancellor are not good.”
If you thought any of this would impact the yield on the 10-year Treasury Note, think again. Indeed, the benchmark government bond continues to be unaffected by political or economic news, good or bad. The fixed-income set on the long end of the curve now seems immune from any and all news of any sort. The 10-year currently offers a yield of roughly 4.39%, virtually unchanged from Friday’s close (Monday was a holiday in U.S. government bond trading).
How long can the 10-year stand aloof from events unleashed? Tough to say, although as long as government bonds retain an ample supply of foreign sugar daddies, why worry? Indeed, a recently published working paper published on the Fed’s web site claims that the 10-year’s yield would be an earth-shattering 150 basis points higher if not for the kindness of offshore strangers. Meanwhile, no word yet on whether all the foreign buyers of dollars have read the paper.