Catch 22 for the White House as the Dollar stays strong

Friday, 9th August 2019 13:32 - by Shant

US intervention on the Dollar has been a topical theme of late, with the US president consistently expressing his disapproval of current strength.  Global trade has been a contentious issue for a number of years in the US, pointing the finger at China and its uncompetitive practices, not to mention the issue of intellectual property 'theft'.  As a result, currencies are leading the headlines and at some point, will take precedence over interest rates - which in the developed economies look to be heading back towards zero and into negative territory en masse.  As is stands, Europe and Japan are already at this stage, and indeed entrenched in this dynamic with seemingly little light seen at the end of the tunnel.  When you consider how long Japan has been conducting its asset purchases in the name of raising inflation - and duly failing - it seems clear the central bank grasp on economic management is receding by the day.  The ECB seems confident that they continue to have the tools to contend with the Eurozone slowdown, but with the region dependent on exports - as reflected in the current weakness in Germany - will or are negative rates going to work anymore?

As such, are we now in a world where central banks may be tailoring policy towards exchange rates?  It is no secret that the Bank of Japan, along with the Ministry of Finance has its eyes firmly on the Yen rate, while the ECB has made similar moves which have been perceived as relevant to the level of the Euro.  The European Central Bank has often made references to the exchange rate in determining its growth and inflation forecasts.  But where does this leave the Fed and the US Treasury?  President Trump to date is directing his ire towards the chairman Powell and his fellow policymakers, seemingly in the view that their decisions should help alleviate some of the upside pressures on the Dollar.  

This are clear reasons why directly intervening in the Dollar at this time is a risky venture.  First up is the firepower required to effect such a move with the Treasury only having $100bln through the ESF (Exchange Stabilisation Fund.  In contrast, China has a plethora of reserves with which to counteract these moves.  Should the President look for more funds to enact this process, then he will need approval from Congress - and that looks unlikely in the current climate, given their objections to his combative stance on trade policy.  In the event of direct market action, we can expect risk sentiment to also take hold, which will then impact on the stock markets - something of a risky move in itself if the president is looking to redress the trade imbalances ahead of the elections next year.

There is however another growing policy directive brewing in the background - and this is the taxation of US asset purchases.  This comes at a time when central banks are ramping up their expectations on fresh QE (save Japan - they are already in full flow) and will look to US fixed income and equity markets.  

Senators Hawley and Baldwin have introduced a Competitive Dollar for Jobs and Prosperity Act which place a market access charge on US assets of all types.  The move would be designed to fight off currency manipulation, in the aftermath of the Treasury labeling China a manipulator as well as helping the Fed to try and balance out the current account, which continues to widen.  The Bill is also expected to raise around $2trln in taxes, but the question for equity markets would be - at what cost?  How will this impact on the performance of Wall Street going forward?  We expect there will be a negative impact to some degree, but in the current climate, it is a significant development which could have serious implications on a market which is seen to be heavily out of line with valuations based on assumed future economic performance.  This is one to watch for sure.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.