U.S. dollar: Victim or victor?

U.S. dollar: Victim or victor?

Pride notwithstanding, the falling dollar can be good news; Draghi edges ever closer to a taper; EU's Brexit hardliners show their mettle


"I will say what Margaret Thatcher used to say: 'We want our money back’”
France’s Finance Minister, Bruno Le Maire, on money the EU is seeking to collect from Britain in association with Brexit

U.S. dollar: Victim or victor?  The U.S. dollar has fallen -8.2%1 this year against a trade-weighted basket of currencies, and is down just under -10% against the euro. While U.S. pundits have been quick to blame recent disorder in Washington for the decline, there are more fundamental reasons for the descent.

Most prominent is a change in interest rate expectations on the short end of the yield curve – largely the result of Fed actions and comments. After three 25 basis point (bps) hikes since the beginning of December, Chair Yellen and her colleagues have shaded their optimism about the economy in light of stubbornly low inflation – leading some to wonder if another hike this year could be on hold.  Currency traders may already have incorporated this doubt; after all, inflation has been below the Fed’s 2% target level for quite some time.

Add to that recent strength in the European economy and ECB President Draghi’s gentle but clear hints that a rate rise could be in the offing – factors which may be driving the euro higher against the dollar in particular.

National pride notwithstanding, a falling dollar is good for U.S. exporters – and in theory for wage and job growth. Which could come in handy, since a falling dollar also means more expensive imported goods for U.S. consumers. The falling dollar is also good for oil importers, since oil is priced in dollars, which are cheaper now. But it’s not so good for oil exporters like OPEC, which has several members badly in need of a financial boost.
 

ECB taper: No tantrum so far Last week’s European Central Bank (ECB) policy statement and press conference were carefully crafted to avoid controversy and sudden market reaction – perhaps due to the sharp moves resulting from the subtle signals from last month’s gathering of central bankers in Sintra, Portugal. That’s one possible reason for the ECB’s unchanged formal guidance about the future of rates and its bond-buying program.

That said, the statements by ECB President Mario Draghi about the timing of any future dial-back of its bond-buying program left the clear impression that the matter would be discussed by the ECB “in the fall”, which was heard by many as meaning at the regularly-scheduled ECB meetings scheduled for early September or late October. Like the U.S., Europe’s economies face stubbornly low inflation rates in the face of gathering signs of growth.

The issues are not just a matter of appearance. The ECB’s bond buying has put cash directly in the hands of struggling European companies, which have used it to rehire laid-off workers, and to restart projects, many of which are directly involved with improving some of Europe’s neglected infrastructure projects. Any reduction in this indirect subsidy could be felt immediately in employment; hence, the importance of ensuring that Europe’s economies can grow on their own before withdrawing this form of life support.
 

Brexit: Europe’s hardliners ascendant Last week’s second round of negotiations between the European Union (EU) and the U.K. on Brexit left little doubt that the EU intends to offer little to none of the “flexibility” that U.K. negotiator David Davis said he was seeking. The EU’s negotiator, Michel Barnier, summed up the session nicely: “I know one has to compromise in negotiations but we are not there yet.”  Others were less gentle; France’s Finance Minister, Bruno Le Maire, used a hearing in the French parliament to talk about the financial settlement that is believed to be part of the eventual deal:  "I will say what Margaret Thatcher used to say: 'We want our money back,"' referring to the estimated maximum €100 bn owed to the EU by the U.K..

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