Now that the Fed has made clear they will look at the current data at each meeting to decide when to raise rates, it's a good idea to ask what that data will be. One factor that will guide and perhaps limit the Fed's flexibility is the dominance of the US dollar.
By Vikram Rangala
Thursday, March 19, 2015
Australia, Canada, Chile, China, Denmark, Egypt, India, Indonesia, Israel, Peru, Poland, Russia, Singapore, South Korea, Sweden, Switzerland, Thailand, Turkey: those are some of the countries that have eased monetary policy in recent months. The ECB has started its QE with plans to buy bonds in such quantities that new euro-denominated bond issues are being planned just to meet the anticipated demand for anything that can be bought with ever-cheaper euros. The dollar has hit a 12-year high against the euro.
Meanwhile, the Bank of Japan has been buying up so much Japanese government debt that other institutions, like the national pension fund, have to look for other investments. They are looking where they can get the best returns and right now that's the US. A U.S. 10-year bond pays over 2 percent, where a German one pays only 0.28 percent.
The demand for dollar-denominated debt, particular US Treasury debt, has caused a surge in the dollar over the past six months unlike any since the 1970s post-oil embargo. The main reason everybody loves the dollar is that they have enjoyed the Fed's dollar-friendly low interest rates.
To simplify it without oversimplifying, low interest rates = strong dollar. So what happens to the dollar now that the Fed has said they might raise rates as early as June? The Washington Post's Wonkblog has an interesting answer: "markets don't believe the Fed." The cite investor surveys that used to show a 50 percent chance the Fed would start raising rates in June. Now that inflation isn't rising and wage growth is stagnant, just 18 percent of investors now believe a June rate hike will happen.
How's that theory? Now that the Fed has stopped saying the word "patient" and signaled that rates could go up in June, investors are saying, "No way they'll raise rates in June" and driving the dollar even further up. In fact, the central banks of all those countries are betting on it. In a way, the Fed is a central bank for the world, maintaining a surging investment product that the rest of the world can stash their wealth in while they reboot their own economies.
Yesterday I made the case that oil prices are a major influence on other markets and on monetary policy, even to the extent of bringing Iran to the nuclear negotation table. Add the surging dollar as an elephant in every room where any other investment or debt is being discussed, whether it's Greece's ability to satisfy the demands of their European creditors or even ISIS's ability to finance its activities with stolen oil.
That's why the Fed had no choice but to move from "patient" to a combination of confident (in the US economy's progress), cautious (about not upsetting that progress) , and conscious that every move it makes will require a counter-move or cooperative move from every other economy in the world.
European stock markets reacted positively to the Fed announcement in their Thursday session, with the FTSE approaching its record high. The euro slumped again as the dollar surged, while negotiations between Greece and its creditors continued as a sideline to this week’s EU summit. Gold rallied, crude oil dropped, and the major economic report of the day, weekly jobless claims from the US Labor Department, rose just 1000 to 291,000 for March 8-14. A second week with jobless claims below 300,000 is seen as a sign of continued employment growth.
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