The Fed Can't Get A Break: What About The Dollar Now?

| About: PowerShares DB (UUP)

Summary

The turmoil following the Brexit vote in Great Britain has created a situation in which money is flowing into the US dollar, strengthening its value.

The initial reaction to this is that this will hurt US economic growth, something a stronger dollar has been doing over the past twenty months or so.

But, where should Fed officials go? The immediate effort will be to keep financial markets and banks functioning, but where does it go then?

Janet Yellen, the Fed's Chair, and her associates just can't seem to get a break.

Earlier this spring, the foreign exchange markets seemed to be signaling that traders really wanted a stronger dollar. Every time officials provided "forward guidance" that the Fed would raise its policy rate in the near term, foreign exchange markets appeared to be indicating their approval.

Well, the Fed didn't raise its policy rate of interest and, as a consequence, the value of the US dollar slipped in foreign exchange markets.

In early April, the euro reached a near-term high of over $1.1400 per euro, and in early May, one British pound reached a near-term high of near $1.4700.

Now, all this has changed.

With the vote taken last Thursday about Great Britain leaving the European Union, Brexit, the direction the value of the dollar was taking reversed.

This morning, it cost only about $1.0900 to purchase a euro and it cost only about $1.3200 for a pound. This represents a 4.4 percent drop in the value of the euro and a 10.2 percent drop in the value of the pound.

This is not quite what the Fed has been looking for. And, coming at the same time that the value of the Japanese yen has dropped by more than 10.0 percent since early March.

The stronger dollar is of concern to the officials at the Federal Reserve System because of the continued weakness in US economic growth.

It has also been a concern to emerging market countries due to the large amount of dollar-denominated debt that have been issued by these countries. Furthermore, the high volatility of the dollar's value over the past couple of years has been of concern to emerging market countries. China has particularly been impacted because of the devaluations that it has recently experienced, the latest one being last August, and the large capital outflows it faces.

Analysts are afraid that the dollar strength might exacerbate the transmission of slow US economic growth to other parts of the world raising the likelihood of another world recession.

Although the Federal Reserve is mandated by Congress to base its monetary policy only on the state of the employment market in the United States and United States inflation, over the past year and one-half, the Fed has had to take into account, more and more, what was happening in other nations and in other markets.

Already Fed officials have been talking continuously with their counterparts in other central banks around the world.

Fed officials do not want the uncertainty and disorder of the current situation to get out of hand.

There will be a meeting of world central bankers later this week in Portugal where the European Central Bank is putting on a conference. Certainly, Brexit and its aftermath will be discussed.

The Fed, along with central banks all over the world, will be working to bring more order to the financial markets and to the banks.

Certainly, there is little worry that, given Brexit and the volatility taking place in world markets, the Federal Reserve will entertain any idea about moving its policy rate higher this year. Things are just too fragile.

But, the huge uncertainty racking world markets right now have to do with the regaining of order in the current political structure of the world.

Not only is Great Britain on the edge of leaving the European Union, but Scotland and Northern Ireland are making noises that could lead to the break up of the United Kingdom. And, then many analysts are saying that with Great Britain leaving the European Union, the end of the European Union is in sight due to the shaky situations pertaining to Greece, Italy, Spain, and others within the organization.

So, what does the Fed do?

For the time being, the Fed stands pat and stays on alert for any cracks in the financial system or the banking system. Here is where we want to watch the Fed's balance sheet as closely as possible to see what it is doing… not just what it is saying.

It would seem as if it will be a long time before we might really see Federal Reserve officials produce a coherent monetary policy aimed at getting the US economy going again. Some would argue that the Fed has not provided us with a coherent monetary policy for some time, so its just business as usual.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.