“It’s hard to argue against the dollar in the short term”.
That’s from Chris Turner, the head of FX strategy at ING in London. Chris spoke to Bloomberg for a short little piece documenting the extent to which the dollar’s stubborn resiliency in the face of Fed rate cut expectations is playing havoc with carry trades.
While it may indeed be “hard to argue” against the greenback at a time when relative economic strength, monetary policy divergence and the safe-haven appeal of USD assets continues to make the case, one person who is still “arguing” is Donald Trump. And loudly so. “The Euro is dropping against the Dollar ‘like crazy’… and the Fed does NOTHING!”, an incredulous Trump shrieked on Friday, just an hour before the euro collapsed into options expiry.
Read more: What’s Behind Friday’s ‘Crazy’ Euro Collapse
The US president went on to exclaim that the greenback is “the strongest in history”, which is kinda, sorta accurate, depending on what measure you’re going by. And when it comes to Trump, “kinda, sorta accurate” is about the best you can hope for.
The Fed’s trade-weighted index is indeed pressing up against highs hit in 2002, which is presumably what the president means.
As amusing as it most assuredly is to watch Trump squirm, the dollar’s refusal to roll over even as US yields plunge and Fed cut expectations remain sticky is a potentially vexing issue. As we’ve been over here on countless occasions of late, the US will end up importing disinflation if conditions don’t change. In addition to further undermining the Fed’s efforts to achieve its mandate (which could, in turn, erode the central bank’s credibility), this state of affairs raises the odds of the US importing an economic downturn for the first time.
Read more: Recession Or No, The Fed Has To Cut Rates Aggressively
Some argue that these dynamics are in part responsible for market participants’ continual pressing of rate cut bets despite the Fed pushing back against the idea that July’s cut and its likely September sequel presage the onset of a full-blown easing cycle.
“It could be that the market is associating a full easing cycle with a somewhat different scenario [than a recession] that ultimately requires much lower short rates”, Deutsche Bank’s Stuart Sparks wrote earlier this month. “If the rest of the world is easing, then on the margin the Fed must ease more in order to short circuit dollar appreciation that would put further downward pressure on domestic inflation, when core PCE inflation has already slipped non-trivially relative to target”, he went on to say.
But ahead of Jackson Hole, a bevy of Fed officials played down the idea that aggressive cuts are in the cards, preferring to wait for evidence of an actual domestic slowdown before committing to the type of cuts the Trump administration (and the bond market) are betting on.
In the meantime, the dollar’s strength is contributing to emerging market turmoil. Much like 2018, idiosyncratic, country-specific flareups are an issue, with Argentina being the poster child. But leaving aside the peso, the Turkish lira snapped a three-month win streak, falling 4% in August and, of course, the yuan had its worst month on record amid fresh trade war escalations.
Ultimately, it was the worst August for EM FX going back more than two decades.
It’s not clear where things go from here. Global growth expectations haven’t really stabilized and there’s little in the way of evidence to suggest they will soon.
EMs are cutting rates, but unless the Fed cuts faster, the scope for easier policy in developing economies may narrow for fear of piling more pressure on vulnerable currencies at a time when the world seems precariously close to a downturn.
Suffice to say Donald Trump isn’t alone in hoping the dollar will take an extended breather – the sooner the better.
