As Trump Threatens To Enter ‘Currency Manipulation Game’, Here’s How FX Intervention Works

On Wednesday, Donald Trump took to Twitter to accuse Europe and China of currency manipulation for the umpteenth time in the past 13 months.

Although Trump’s “manipulation” allegations date back years, in the context of his presidency it’s easiest to trace things to July 2018, when, following a landmark interview with CNBC’s Joe Kernen which marked the first time the president had openly criticized Jerome Powell, Trump unleashed a series of tweets that suggested he might be prepared to intervene in the FX market to push the dollar lower.

At the time, market participants were somewhat surprised, not that Trump would weigh in, but rather at how brazen he was about doing it. Scotiabank’s chief FX strategist Shaun Osborne, for instance, called Trump’s tweets “excessive” and indicative of the President’s “willingness to run over conventional policies”.

Then, as now, Trump was concerned that a stronger dollar would water down the impact of the tariffs and thereby handicap the US in the trade war.

Since then, talk of actual FX intervention by the US has died down, primarily because Trump’s incessant bullying of Powell and the uncertainty created by the trade war have together convinced the Fed of the need to lean dovish and, in all likelihood, cut rates. The assumption is that between a decelerating US economy, plunging yields and Fed cuts, the dollar will finally crack under pressure, placating Trump.

But that’s not a guarantee. The FOMC’s global counterparts have embarked on easing cycles of their own and economies in Europe and Asia may well continue to underperform the US even as Trump’s MAGA economy cools. As we saw on Monday, the path lower for the dollar isn’t likely to be a one-way trade.

Of course, Trump doesn’t like it when things don’t go as planned, which is why some believe his implicit FX intervention threats aren’t entirely idle.

The president’s Wednesday tweet was somewhat ambiguous. He accused China and Europe of “playing [a] big currency manipulation game” and then proceeded to say the US should “MATCH” (all-caps in the original) or else risk “being the dummies”.

Read more: After Slapping ‘Abuser’ Vietnam With 400% Tariffs, Trump Tells ‘Manipulators’ China, Europe He’s No Dollar Dummy

Trump’s “MATCH” tweet was probably nothing more than another exhortation for the Fed to cut rates, but, again, rumors were flying last summer that the administration might actively intervene in the FX market. Now, those rumors are flying again.

“President Trump has been tweeting again”, SocGen’s Kit Juckes sighed, in a July 4 note, on the way to delivering the following brief history lesson:

Since 1995, the US has only intervened in the FX market twice — against the yen in 1998 and the euro in 2000. That’s a contrast to the interventions that followed the Plaza accord in 1985, but those came against a backdrop of a co-ordinated approach to FX policy. Even so, it’s worth noting that while the US ignored complaints of ‘currency war’ when the dollar was weak in 2010, those comments were a decent predictor of the dollar’s turn higher in 2011. At the very least, the President’s remarks reflect the fact that the dollar is too strong. 

This was already starting to come up again before the president’s Wednesday social media mini-rant. Competitive easing, trade wars and currency wars are inherently related and, in many respects, synonymous, so whether explicit or implicit, overt or tacit, this is a discussion we’ve all been having since Trump became president.

“The strong dollar stands in the way of [Trump’s] goal to boost exports and support the US manufacturing sector. So what can he do about it?”, BofA asked, in a June 21 note.

After reiterating the extent to which the president’s Fed criticism is a plea for Powell to rein in the dollar, the bank notes that Trump has resorted to verbal intervention on all manner of occasions, but with “diminishing effects”.

(BofA)

So, what about formal currency intervention? We went over the mechanics of this last summer in “Presenting, The Dollar Intervention Delusion“, and BofA recaps the process as follows:

At its simplest, the US Treasury will guide the NY Fed’s market desk to intervene. If the goal is to weaken the dollar, the NY Fed would sell dollars and buy the other currency. The currencies that are used for intervention come from the Fed’s holdings and the Exchange Stabilization Fund of the Treasury, which largely consist of euros and Japanese yen.

Sterilized intervention (i.e., accompanied by the buying/selling of sovereign bonds) keeps FX intervention from affecting monetary policy, while unsterilized intervention can feed through to rates and the money supply.

The longer history of FX intervention finds the US intervening fairly often to stabilize the greenback. “The late-1970s marked a period of aggressive intervention given that the dollar was under heavy pressure and depreciated on the back of high oil prices, high US inflation and widening deficits”, BofA reminds you, before recapping the Plaza Accord. The bank goes on to note that “the 1990s marked the final stage of big dollar interventions” with the Treasury and Fed intervening “in the face of a weakening dollar on the back of the Gulf War” and again in 1994 when the US “intervened repeatedly, coordinating with the Japanese and individual European central banks to support the US currency”. Since then, BofA cites just three instances of intervention, the two mentioned by SocGen’s Juckes and another in 2011 involving yen selling.

Would formal intervention by Trump be legal? Well, not really. Or at least not by international standards when FX vol. is subdued. Of course, Trump arguably doesn’t follow clearly written domestic laws, let alone vague international gentlemen’s agreements, so he isn’t likely to care too much what the rest of the world thinks. That goes double when you consider his view that everyone is manipulating their currencies all the time, while the US, quote, “continues being the dummies who sit back and politely watch as other countries continue to play their games”.

The bottom line is that if rate cuts from the Fed do not succeed in bringing about significant dollar weakness, and if the trade tensions worsen, prompting the greenback to regain its safe-haven appeal, Trump may well resort to formal intervention. Historically, that works only to the extent the efforts are targeted and limited.

As BofA dryly notes, attempts to intervene in the interest of “targeting a long-term level of competitiveness… could have negative side effects as it creates distortions and could work against other policies if not coordinated properly with the central bank”.