On Friday, having apparently learned absolutely nothing from the rather unfortunate series of events which unfolded a week previous, Larry Kudlow again ruled out currency intervention by the Trump administration.
“We have ruled [it] out”, Larry told Bloomberg’s Jonathan Ferro, in an interview.
He was responding to a question about what happened on July 26, when Kudlow made similar remarks on CNBC only to be contradicted by Trump hours later.
Read more: Will Donald Trump Resort To Currency Intervention To Bring Down King Dollar? No! Yes! Maybe!
“[The president] said having a strong dollar, there’s a reason it’s so good”, Larry insisted. “I stand by those remarks”.
Frankly, it’s embarrassing to watch Kudlow labor under the kind of impossible conditions the president creates for his subordinates. Larry isn’t fooling anybody and he especially wasn’t fooling Ferro, who pressed him in the kind of straightforward, matter-of-fact way that makes it very difficult for people (in this case Kudlow) who are trying to hide their own frustration with a given situation to persist in the charade.
The dollar came off a bit following this week’s trade escalations, but is still sitting near a 27-month high. The Fed’s reluctance on Wednesday to validate market expectations for additional rate cuts catalyzed an unwelcome upside lurch.
The bottom line is that the odds of Trump intervening via Steve Mnuchin’s Treasury are at least 50/50, and Kudlow surely knows it.
We’ve been over the mechanics of FX intervention on innumerable occasions in these pages. We’ve also documented the history of such intervention efforts and explained why any unilateral intervention is unlikely to be very effective.
Read more in our currency wars archive
Given Trump’s penchant for ignoring his advisers, traders are keen on teasing out the possible implications of Mnuchin wading into the FX market. Our buddy Kevin Muir (of Macro Tourist/Market Huddle fame) weighed in Thursday, noting that the most obvious read-through would be a spike in moribund G7 FX vol.
“Regardless of your views of the US dollar, buying gamma in FX-land is probably the best long vol. position out there right now”, Kevin said.
In the same vein (i.e., as part of a broader effort to think about what might happen in the event Kudlow is wrong to say the administration has “ruled out” FX aggression), SocGen was out this week with a note documenting what happened during historical interventions.
“In only a few occasions since currency markets became free-floating (1971-73) have USD interventions occurred, and only when the USD valuation was extremely low or high (1978-79, 1985-87, 1995)”, the bank wrote, adding that “against the EUR, the USD is currently trading close to two standard deviations above its fair value on a PPP basis, a level that has rarely been in its history”.
(SocGen)
That ostensible overvaluation raises the odds of intervention – especially given who’s in the Oval Office.
SocGen goes on to note that “periods of large currency interventions have historically been accompanied by difficulties for the S&P [and] more volatility because of increased uncertainty”.
(SocGen)
That underscores one of the most worrisome aspects of potential intervention by the Trump administration. Virtually nobody you care to ask would suggest that the mechanical act of intervening will work to bring about the kind of sustained dollar weakness the US president is after. The signaling effect, though, could be substantial.
The problem is that the market would likely interpret intervention has a serious escalation on the trade front that raises the odds of other escalations, such as the aggressive application of countervailing duties, as quietly tipped by Wilbur Ross’s Commerce department on May 23.
Read more: Did The Trump Administration Just Announce A Major Currency Escalation?
More escalations mean more volatility, and not just in FX land. The implication for rates is that, to speak colloquially, an already manic landscape would become even more so.
“If the Fed endorses the Treasury’s efforts, thereby increasing the potential for an increase in the supply of dollars, or if it communicates a more accommodative path for rates, the dollar curve will likely respond by steepening”, SocGen muses, before cautioning that ” if the Fed does not endorse the Treasury’s efforts or is reluctant to provide additional monetary policy accommodation, the curve will likely bull flatten as the front-end remains pegged to Fed expectations”.
It is, of course, very unlikely that the Fed would refuse to participate alongside Mnuchin, but if Powell did push back, SocGen warns that the central bank’s reluctance “would likely render FX intervention ineffective and increase financial instability concerns”.
Meanwhile, Pimco this week joined the chorus of those (implicitly) advising against intervention. In a short note, Gene Frieda and Tiffany Wilding cited the same concerns as everyone else, with an emphasis on:
- the US having insufficient fire power to make a dent (they don’t mention this, but we would note that there is a “tinfoil hat” scenario being bandied about that involves the Fed resorting to some kind of dramatic maneuver like liquidating its balance sheet);
- a lack of international cooperation;
- the likelihood of unilateral intervention being seen as an extremely hostile act.
We’ll leave readers with three short passages from Pimco:
With the Treasury’s capacity to intervene in currency markets limited to the $95 billion in the Exchange Stabilization Fund (according to the last ESF financial statement), that implies a cumulative $190 billion potentially available for U.S. intervention if the Fed participates — an amount that is likely to fall short of the force required to sustainably weaken the dollar.
It becomes even more important, then, that the U.S. win cooperation from international peers. However, other developed market governments and international agencies largely discourage currency intervention by leading nations. And in the current environment of global trade frictions, intervention to competitively devalue the dollar is even more unlikely to gain their support.
Without international cooperation, U.S. currency intervention would probably be seen as a provocation and further exacerbate trade frictions. This would be particularly so if the intervention were targeted solely at the Chinese yuan rather than a set of major currencies. In the worst-case scenario, Washington would intervene following a currency depreciation by China in response to higher U.S. tariffs.
If the fed liquidates it’s balance sheet doesn’t that means it sells treasury and mortgage securities and suck dollars out of bank reserves?
well, the idea would be for the Fed to make more dollars available for the purpose of intervention. and they have a shit load of dollars on that balance sheet.
Question.
Usually when the dollar is high the price of gold goes down and vice versa. I assume that’s true for all countries and their currencies? With so many countries and currencies devalued is that one reason why gold is going higher even with the dollar holding it’s own?? People in those other countries are buying defensively.