Why the Dollar is Continuing Lower

The combination of the apparent resolution of the West LB situation and the FOMC minutes have conspired to send the US dollar broadly lower today.

The FOMC minutes in particular have been seized upon. On one hand, it is unusual for the FOMC to give so much space to a discussion about the dollar. This is, however consistent with what appears to be a stepped up campaign by both Treasury and Fed officials to cite the dollar in an unsolicited way. The ostensible purpose is likely to demonstrate that there is no "malign neglect."

On the other hand, what they did say was essentially what Bernanke said last week: that the Fed is monitoring developments in the foreign exchange market and the dollar's price action is not jeopardizing the FOMC's ability to pursue its dual mandate. To the extent there seemed some net additive in the minutes, it is the formal recognition of potential negative consequences of very low short-term interest rates for an extended period of time: it "could lead to excessive risk-taking in the financial markets."

So, the Fed recognized the concerns US officials heard at the recent G20 and APEC meetings, and then dismissed them: "While members currently saw the likelihood of such effects as relatively low, they would remain alert to these risks."

At the same time, the minutes suggest the Fed generally sees the dollar's decline since March as largely an unwinding of the safe haven gains scored in H2 08. The bottom line is that although the dollar is having a greater role in the declaratory policy, operational policy has not changed. That said, we continue to suspect that if formally requested by the other major central banks, justifiable on the Fed's conditions--boosting inflation expectations or producing excessive risk-taking, US policy makers might not dismiss it out of hand. One implication of this observation is that despite the jawboning and words of warning, it does not appear ECB officials or Japanese officials are prepared to do anything either.

Disclosure: No positions

Comments

[derryl]

Savers/investors have boatloads of money and spenders have too much debt and diminishing employment prospects. The Fed's dual mandate is price stability and maximum employment. Reduced domestic spending puts deflationary pressure on CPI prices while a shrinking dollar adds inflationary pressures on imports like oil.

Monetary easing in the form of low interest rates is the standard policy to increase credit and spending and stabilize prices in a deflationary environment. Increased spending also increases employment. So both aspects of the Fed's mandate suggest continuation of the monetary easing policies.

China's yuan is tied to the dollar so inasmuch as consumer goods are imported from China, a lower dollar will not affect CPI prices. America's other major import, oil, would trend higher with a falling dollar. As oil is an input into virtually all prices, mainly due to the need to transport goods, higher oil will put inflationary pressure on CPI prices. Higher input costs and tight domestic spending will squeeze profit margins for US producers and retailers. But squeezed profits absorb some of the oil price inflation so CPI prices will not necessarily follow oil up point for point.

On balance I don't think the Fed has much choice but to continue its monetary easing policies, and quite possibly expand them, in the face of the secular deflationary trend. Interest rates are going nowhere "for an extended time".

2009 Nov 25 10:52 AM

[Gary A]

It is a Ying and Yang Derryl, but what if oil goes so high that the economy tanks anyway? It likely will if interest rates don't go up. And if oil goes up all the stimulus, which is probably overblown in job savings will be for nothing. And bailing out the big banks will be for nothing. So really there are no good choices, but more debt is the worst choice.


On Nov 25 10:52 AM derryl wrote:

> Savers/investors have boatloads of money and spenders have too much
> debt and diminishing employment prospects. The Fed's dual mandate
> is price stability and maximum employment. Reduced domestic spending
> puts deflationary pressure on CPI prices while a shrinking dollar
> adds inflationary pressures on imports like oil.
>
> Monetary easing in the form of low interest rates is the standard
> policy to increase credit and spending and stabilize prices in a
> deflationary environment. Increased spending also increases employment.
> So both aspects of the Fed's mandate suggest continuation of the
> monetary easing policies.
>
> China's yuan is tied to the dollar so inasmuch as consumer goods
> are imported from China, a lower dollar will not affect CPI prices.
> America's other major import, oil, would trend higher with a falling
> dollar. As oil is an input into virtually all prices, mainly due
> to the need to transport goods, higher oil will put inflationary
> pressure on CPI prices. Higher input costs and tight domestic spending
> will squeeze profit margins for US producers and retailers. But
> squeezed profits absorb some of the oil price inflation so CPI prices
> will not necessarily follow oil up point for point.
>
> On balance I don't think the Fed has much choice but to continue
> its monetary easing policies, and quite possibly expand them, in
> the face of the secular deflationary trend. Interest rates are going
> nowhere "for an extended time".

2009 Nov 26 12:44 AM

[bob adamson]

On the other hand, the sudden emergence into full view of Dubai’s debt problems and its impact on the UAE generally might well trigger a modest resurgence of the US dollar Arguably the dollar was already ripe for a ‘dead cat bounce’ given some catalyst. This is not to say that current trends are reversed on a longer term basis but only that the commodities may correct a bit and the dollar firm for the balance of the year. Not trends I was expecting until today.

2009 Nov 26 09:08 PM