The Fed’s Dollar Problem

I have to admit that when it comes to the actions and behaviour of central banks in today’s global financial markets, I do take a somewhat sadistic pleasure from the sidelines. This is because we really are normally looking at a case of the tail wagging the dog. To think that they can really wield power against the wall of money flowing around the world, has to be somewhat fanciful. This is especially the case given the way that one suspects much of this flow is not tax paid, not exactly transparent as to its origins, and may be the result of capital flight from geopolitical turmoil and assorted Third World dictators and their friends. Even worse, from a fiscal perspective, cash that pours in can just as easily pour out.

But this general point which is difficult enough in itself, leads us quite neatly into the current plight of the Federal Reserve, and what it may do on interest rates. The perspective which it seems correct to take is that the market has been bracing itself for a rise in U.S. interest rates for months, with the rise in the U.S. Dollar mirroring these expectations. The problem is that while there has undoubtedly been a delay to the timing of a possible interest rate rise, it has been flagged for so long, it may be that the Fed are already boxed into a corner. This theory adds to the one that I have that they would find it very difficult to do so anyway. It is over and above the idea that appointing the most dovish person in the United States as Fed Chair was always going to guarantee rates only went up if they really had to. The reality is that not only do they not really have to (there is no inflation of significance, the economy is not exactly overheating, sovereign debt is so great and Government cash so tight), the last thing that is needed is higher rates.

All the while though, the greenback has soared, taking the stock market with it. But is this just the smart money taking a punt on Yellen finally pushing the button, or something else? The explanation as to why the Dollar has pushed Sterling to below $1.50 and towards parity versus the Euro looks to be even more than just speculators seeking yield in an atmosphere of competitive devaluation/deflation. Such a view would certainly be the conventional wisdom on the matter, but it would appear there is more. There would have to be more to explain the magnitude of the Dollar gains.

The most obvious suggestion is capital flight. Liquidation of Euro positions on Grexit fears and of course, the collapse of the Rouble. The latter cannot be underestimated given that by the start of this year the Russians bought $75bn worth of their own currency in order to prevent a total collapse. Clearly, there was at least $75bn worth of Russian money heading out of the door – despite Putin getting back Crimea and a chunk of Ukraine (sort of).

So the problem for the Federal Reserve looks like it could be attempting to raise interest rates at a time when the rise of the Dollar may be uncontrollable. This may be regarded as the equivalent of pouring petrol on a fire. To conclude, we still do not know whether Janet “Dove” Yellen has ever really been serious about raising rates, how much she intends to raise them, or perhaps most important of all, whether this is going to be possible against a backdrop of an already soaring U.S. currency. Let us say that the Fed’s hands would appear to be well and truly tied. On this basis it may be that the “no change” stance lasts rather longer than most in the market are expecting.