Well, you can add Goldman to the list of Wall Street banks out warning on the risk of formal FX intervention from the Trump administration.
Over the last several weeks, speculation about the prospect of the White House instructing Steve Mnuchin to wade into the market in order to put downward pressure on the dollar has mounted. On Wednesday, reports indicated that Trump broached the FX subject with his latest Fed picks Judy Shelton and Chris Waller.
The issue, in short, is that with the US economy still the proverbial “cleanest dirty shirt” and the FOMC’s global counterparts pivoting dovish and easing in tandem with the Fed, it’s not a foregone conclusion that the dollar will weaken, despite Jerome Powell’s newfound penchant for accommodation.
Indeed, the greenback steadfastly refused to roll over in H1, even as US yields collapsed.
As Goldman reminds everyone on Thursday, anything is possible with this administration.
“A series of comments by President Trump and policy actions or proposals by his administration have brought US currency policy back into the forefront for investors [and] this comes against a backdrop where the President has surprised investors on trade policy issues, which has created a perception that ‘anything is possible'”, the bank writes, in a new note.
Although formal intervention isn’t Goldman’s base case, the bank acknowledges that “outright, active FX intervention in an attempt to weaken the Dollar… is a low but rising risk”.
The bank of course cites the infamous “Mario D.” tweets as well as Trump’s renewed exhortations for the US to “match” the “big currency manipulation game” that, at least to the president’s mind, is being perpetrated by Europe and China.
Goldman also mentions the expansion of the Treasury’s monitoring list and the Commerce department’s stealth FX broadside detailed extensively here in “Did The Trump Administration Just Announce A Major Currency Escalation?”
After recounting the shrill rhetoric and foreboding circumstances that have the market on tenterhooks, Goldman reminds everyone about the mechanics of this. To wit:
First, technically both the Treasury and the Federal Reserve have authority to intervene in currency markets—the Treasury through the Exchange Stabilization Fund (ESF) and the Fed through its own balance sheet (although in both cases the Federal Reserve Bank of New York executes the transactions). In the past, the two institutions have almost always participated 50/50 in intervention operations, although this is not a statutory responsibility for the Federal Reserve. The Treasury could choose to “go it alone,” but this would substantially limit the potential scale of intervention as the ESF holds a fairly small amount of assets—currently about $22bn in US Dollars and another $51bn in SDRs that could be converted. Even in this case, we would expect that the symbolic importance of this step would still have a significant market-moving effect. However, it is far from clear that the Fed would not participate. Recently, Chair Powell has stated that “the Treasury Department…is responsible for exchange rate policy, full stop.” Our interpretation is that the Fed would probably defer to the Treasury and go along even if it does not agree (as it did a number of times in previous intervention episodes).
Having rehashed the technicalities, the bank walks through the various “practical issues”, starting with the idea that a coordinated approach involving other countries isn’t likely feasible. Beyond that, Goldman notes that any formal intervention would be seen for precisely what it is: A trade escalation. “[That] could be counterproductive”, Goldman rather dryly observes.
As far as the yuan goes, the situation is immeasurably more complicated, something we detailed last August when rumors about formal intervention were flying around as they are currently. “China is the world’s largest holder of reserves, and a substantial portion of that is held in Dollar assets, although we maintain that disinvesting from Dollar assets at this point would run counter to its macro goals”, Goldman writes. That said, the bank also remarks that capital controls “and a limited number of investable assets in China would likely restrict the US’s ability to respond”.
And then there’s the question of whether the US would actually want to do this given what it would entail. As Goldman puts it: “While the size of the US balance sheet might have more influence over the currencies of smaller trading partners, there would still be the operational question of whether the US wants to hold foreign reserves in less-liquid (and potentially lower-rated) assets”.
All of that said, don’t rule it out. After all (and as mentioned by BofA and plenty of other desks recently), this wasn’t uncommon decades ago and furthermore, Goldman reminds you that “while direct intervention is no longer in vogue, central banks have increasingly become more proactive in their use of balance sheet tools, and it is not a giant leap from there to intervention”.
That latter point is probably the most critical. As we put it two weeks back, 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.