The Fed Raised Rates For The First Time In Three Years. The Dollar And Global Yields Are Feeling It.

The Federal Reserve’s first interest-rate increase in more than three years is rippling through global financial markets, strengthening the dollar and keeping bond yields elevated as central banks contend with renewed inflation pressure tied partly to higher energy costs.

The Fed on Wednesday raised its benchmark federal funds rate by a quarter percentage point to a range of 3.75% to 4%, its first increase since July 2023. The Federal Open Market Committee approved the decision unanimously and said inflation remained elevated while economic activity continued to expand at a solid pace, Federal Reserve data showed.

The move came after months of rising energy prices linked to the Middle East conflict added to U.S. inflation pressures. Fed officials have also been watching resilient domestic spending, a relatively stable labor market and strong capital investment as they assess inflation.

The immediate market response extended beyond the United States. The dollar climbed to a seven-week high Thursday after the rate decision before giving back some of those gains as oil prices declined, Reuters reported. The dollar had already strengthened in the days leading up to the meeting as higher crude prices pushed Treasury yields higher and traders positioned for tighter monetary policy.

Higher U.S. interest rates generally increase the relative appeal of dollar-denominated assets, putting additional pressure on currencies in economies where central banks are pursuing different monetary policies. Mark Zandi, chief economist at Moody’s Analytics, told CNBC that the Fed decision and its policy signals were putting upward pressure on the dollar and downward pressure on other currencies.

That pressure has been particularly important because oil, natural gas and many agricultural commodities are priced in dollars. A weaker local currency makes those imports more expensive even before changes in the underlying commodity price are taken into account.

The effects differ significantly between economies. China and Thailand have been dealing with deflationary pressure, while inflation in Australia and Japan has remained above their central banks’ targets. India has faced another problem from the combination of higher oil prices and dollar strength. The rupee touched its weakest level since late July ahead of the Fed decision as corporate dollar demand and oil prices above $100 added pressure, Reuters reported.

Japan is also dealing with the interaction between its currency and interest rates. The yen has strengthened recently as investors have focused on the Bank of Japan’s monetary policy, although the gap between Japanese and U.S. interest rates remains an important factor in currency trading.

The Fed is not the only major central bank that has tightened monetary policy as energy prices have pushed inflation higher. The European Central Bank raised all three of its key interest rates by 25 basis points last week, taking its deposit rate to 2.50%. The European Central Bank explicitly cited inflation pressures generated by the Middle East conflict when announcing the decision.

Bond markets have reflected that shift. The U.S. 10-year Treasury yield reached 5% after the Fed decision Wednesday, while shorter-term yields also rose. Germany’s 10-year government bond yield had climbed to its highest level since 2009 earlier this week before retreating as oil prices eased, Reuters reported.

Higher government yields also change the calculations facing equity investors because bonds offer greater returns while companies face more expensive financing. U.S. stocks initially moved lower following Wednesday’s Fed decision, with the Dow Jones Industrial Average falling 1.21% and the S&P 500 declining 0.45% by the close. The Nasdaq Composite finished nearly flat, Reuters reported.

Oil remains another major part of the interest-rate picture. Prices have climbed sharply during the Middle East conflict as disruptions and tensions surrounding major shipping and production routes affected energy markets. Brent crude had moved close to $110 a barrel earlier this week before retreating as Saudi Arabia offered additional supplies, easing some immediate concerns about disruptions.

The energy shock has already played a role in monetary policy outside the United States. The ECB said last week that the Middle East conflict continued to generate inflation pressure, while the Federal Reserve noted in its July monetary policy report that inflation had risen sharply in March after energy prices surged following the start of the conflict.