I wouldn’t want to be Christine Lagarde or Andrew Bailey right now.
For months, FX folk wondered about the fate of the euro and the pound in the event the US economy continued to outperform, compelling the Fed to push out the first rate cut.
On Wednesday, a third consecutive US CPI overshoot served as the coup de grâce for whatever was left of June Fed cut pricing. Predictably, the common currency and sterling plunged.
If history’s any guide, July 31 is more than three months away. A lot can happen in three months, which is to say a cut at the July FOMC gathering’s still possible. But in all likelihood, we’re talking about September.
That’s problematic for the ECB and the BoE, both of which (or “whom,” if you prefer) may well start cutting before then. Indeed, Lagarde will probably confirm the ECB’s intention to cut in June later this week. The BoE, you’ll recall, is plainly leaning towards cuts as evidenced most clearly by the capitulation of hawkish dissents over the last two policy meetings.
Long story short, we may be on the cusp of a rather glaring policy divergence between the Fed and its counterparts in Frankfurt and London. That, in turn, suggests dollar strength.
As the simplest of simple figures (above) shows, markets are anticipating that policy divergence.
In the wake of Wednesday’s US CPI report, the greenback was on track for its largest one-day rally since Jerome Powell’s March 2023 congressional testimony (on the eve of SVB’s implosion).
Is that as foreboding as it looks (or as ominous as my deliberately overwrought editorial tone makes it sound)? Well, maybe.
When the dollar’s on the back foot, the world’s a much friendlier place. When the greenback’s flexing… well, there’s a reason they call it a “wrecking ball.”
I have a somewhat different view. Growth is slower in developed markets outside the US. So their short term policy rates should be lowered and their currency should decline. This on balance will increase their growth and inflation relative to the US. Isn’t that supposed to happen? As long as it is reasonably anticipated, that would seem to be a good outcome. Am I missing something here?
Well, from a 30,000-foot perspective a strong dollar’s negative for global liquidity, but more narrowly, you’re implicitly (and probably accidentally) assuming that commodity prices, and particularly oil, don’t rise alongside dollar strength. If you’re a net energy importer with a weak currency in an environment where USD-denominated energy prices are rising, you’re looking at a terms of trade shock.
Explainer for the newbie? What’s the reason it’s a “wrecking ball”?
This posting is looking more & more relevant, isn’t it?
You never would have seen this headline 25 years ago!
• Japanese financial authorities should consider conducting coordinated currency intervention with other countries to support the yen, the head of the Tokyo Chamber of Commerce and Industry said.
Another example of your earlier reply to RIA.
Thankfully, according to Politico, Trump’s economic advisors are pondering a plan to weaken the dollar.