NEW YORK (TheStreet) -- The dollar will get stronger through the rest of this year, and you'll have the Federal Reserve to thank -- or blame -- for it.
Federal Reserve policymakers are expected to begin raising the target range for short-term interest rates this year, and expectations alone of this increase are enough to move financial markets.
For example, the value of the dollar increased versus the euro and the pound in anticipation of Federal Reserve Chair Janet Yellen's appearance before Congress Wednesday morning. The Wall Street Journal's dollar index also rose in anticipation of her testimony. Yellen's testimony was released Wednesday morning before her actual appearance.
The Fed is mandated to use monetary policy in order to foster maximum employment, stable prices and moderate long-term interest rates.
In her testimony, Yellen says the employment situation has improved, with the unemployment rate dropping to 5.3% in June. Yellen also points out that the inflation rate is below the central bank's target rate of 2% but is not showing signs of weakening.
As far as economic growth is concerned, Yellen states that the second-quarter GDP growth is expected to pick up after a dismal, weather-related first quarter. The growth rate in the first half of 2015 will not be anywhere close to the 3.5% rate of growth that was achieved in the second half of 2014, however.
For one thing, Yellen points to industrial production in the second quarter of 2015 and admits it has not been very strong. The June number for industrial production was released before her testimony and came in with a very weak 1.5% year-over-year rate of expansion.
Furthermore, the June numbers for retail sales did not point to a very strong quarter.
Still, Yellen notes that the Federal Open Market Committee said in its most recent statement that "it would be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."
She continues, "If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target, thereby beginning to normalize the stance of monetary policy."
Still, what will be important is the future evolution of short-term interest rate increases.
"Indeed, the stance of monetary policy will likely remain highly accommodative for quite some time after the first increase in the federal funds rate in order to support continued progress toward our objectives of maximum employment and 2.0 percent inflation," she says.
There you have it. The Fed will raise interest rates but will probably not raise them too rapidly.
The only time Yellen mentions the U.S. currency is when she comments on slow economic growth and how it has been affected by the appreciation of the dollar.
The value of the dollar is going to be affected by rising U.S. interest rates, particularly because other central banks are expected to continue policies of quantitative easing for some time.
Compared with other major central banks, the Federal Reserve will be producing the least expansionary policy over the next 12 months. The value of foreign exchange rates is all relative to what is happening in two countries, and so this is an important distinction.
The unknown question relates to how sensitive the Federal Reserve will be to further appreciation in the value of the dollar. Will it resist raising the target for the federal funds rate if the value of the dollar gets much stronger?
For example, a reasonable argument can be made that the value of the euro will drop from current levels near $1.10 to $1.00. That would likely result in even weaker export numbers and weaker growth.
Will the Fed stand for this? This is an issue that Yellen and other members of the Fed will soon have to face.