‘Beggar Thy Neighbor’ Here We Come?

On Friday, the Trump administration sent conflicting signals to the market when it comes to the likelihood of unilateral FX intervention to weaken the dollar.

Speculation that Trump will instruct Steve Mnuchin to wade into the market is running at a fever pitch and it turns out the president in fact discussed it during a meeting at the White House last Tuesday. According to reports, Peter Navarro argued in favor of intervention, while Mnuchin and Larry Kudlow pushed back.

Once news of the pow wow leaked to the press, Kudlow confirmed the talks during a contentious Friday interview with CNBC, during which Larry told his old colleagues at the network that the administration had “ruled out” intervention. Hours later, Trump said he had done no such thing – all options are still on the table when it comes to the dollar.

Read more: Will Donald Trump Resort To Currency Intervention To Bring Down King Dollar? No! Yes! Maybe!

Now, nobody knows what to think.

Trump was back on Twitter complaining about monetary policy on Monday and his remarks clearly suggest he doesn’t think the Fed will do enough to offset (or “match”, as he’s fond of saying) the ECB and the PBoC.

“The EU and China will further lower interest rates and pump money into their systems, making it much easier for their manufacturers to sell product”, Trump lamented. “[The Fed] will probably do very little by comparison”.

In light of the ongoing debate, Goldman is out with a short new piece analyzing the effects of unilateral US FX intervention for non-US rates.

“Without coordination with other major central banks, unilateral intervention risks turning into a series of competitive interventions by global central banks”, Goldman warns. That scenario would be bullish for ex-US rates for two reasons. First, it would likely engender risk-off sentiment, but second, it would almost assuredly prompt foreign central banks to try and curb any domestic FX appreciation.

Obviously, Europe and Japan are battling disinflation, so just about the last thing they need is Donald Trump stomping around in the FX market driving the dollar down (and driving up the euro and the yen). As Goldman puts it, “if the US embarked on unilateral currency intervention that succeeded in pushing the Dollar lower, the growth and inflationary effects come at the expense of other markets — the ‘beggar thy neighbour’ effect of competitive devaluation”.

Goldman uses “the impact of Fed-induced changes in EUR/USD on inflation swaps” (controlling for oil prices, risk assets and US inflation) to proxy for the impact of FX intervention on EU inflation markets. Specifically, the bank uses “returns of EUR/USD over a +/- one-hour window around Fed meetings… to explain the subsequent one-week move in EUR inflation swaps”.


The point there is that the impact on EUR inflation swaps is larger for Fed-induced changes in EURUSD than it is in response to simple EUR appreciation.

“The likely market response in the markets targeted by US FX intervention would be a decline in market-based inflation and a rally in nominal rates”, Goldman says, stating the intuitive conclusions from their analysis, and adding that “to the extent that policy is invoked to counter the effect of currency appreciation (namely in a true non-cooperative version of intervention), real rates may also decline”.

Again (and as indicated by the chart header), Europe and Japan are simply not in a position to cope with a disinflationary shock right now, which means the ECB and the BoJ would likely be compelled to hit back at Trump. Hence Goldman’s warning about “a series of competitive interventions by global central banks” and bullish implications for non-US rates.

On the bright side, Goldman thinks the window for Trump to attempt this is quickly closing. One of the main risks associated with going this route involves a selloff across risk assets as investors view it as a serious escalation in the trade war with the potential to spiral out of control. Mnuchin has probably informed Trump of that possibility and it seems unlikely the president would be keen on doing anything that might upend stocks the closer we get to the election.

Or so one hopes, anyway.


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