Will Powell bend to Trump's desire for lower US dollar?

London

NOTWITHSTANDING its retreat from the peak in recent days, the US dollar's latest rally is underpinned by several factors.

The reasons for its strength this year have been emerging nation foreign currency debt repayments, a strong American economy, a trade deal with Mexico and a potential agreement with Canada.

Despite the US's large twin deficits, notably its balance of payments current account negative gap and widening budget deficit, global investors have purchased high yielding US Treasury bonds. The yields, currently between 2.6 to 3 per cent, depending on the duration of the bonds, are far higher than yen, German, French and British government bonds.

"Last year foreigners were again the single biggest source of Treasury buying, as reserve manager purchases picked up again amid dollar weakness," said Robin Brooks, managing director & chief economist, Institute of International Finance.

Despite all those bullish factors, global investors are wary because the Trump Administration prefers a weak dollar to keep the US competitive. The US dollar index, which comprises six major currencies euro, yen, sterling, Canadian dollar, Swedish kroner and Swiss franc, rose by 10.2 per cent from 88 in February to a peak of almost 97 in mid August. Since then, it has fallen by 2.5 per cent to 94.6.

The decline against major currencies accelerated after the new Federal Reserve Board governor Jerome Powell disappointed the markets at a central bank meeting in Jackson Hole. Several economic commentators had spun the story that Mr Powell, a Trump appointee, would be independent; that he would not be influenced by the wishes of the President or any other politicians. Instead Mr Powell said in his speech that the Federal Reserve would pursue a policy of gentle interest rate rises to curb inflation. Market participants were not impressed with quarter percentage poiint rises from the low base.

What particularly disturbed some economists was the following claim in Mr Powell's speech: "While inflation has recently moved up near 2 per cent, we have seen no clear sign of an acceleration above 2 per cent, and there does not seem to be an elevated risk of overheating."

Official US figures, however, show that US consumer price index has accelerated from 2.1 per cent in January to 2.9 per cent in June and July. In real, inflation-adjusted terms bond yields and other interest rates are negative.

Moreover, monetary economists such as Brendan Brown at Mitsubishi UFJ Financial Group (Europe) say that the US authorities adjust inflation downwards via "hedonic accounting" e.g. better quality of goods sold. Excluding these adjustments, US inflation would be 4 per cent or higher.

In other words, small rate rises would have limited effect in curbing inflation. The market also expects interest rate rises to be negligible because on November 6 voters will elect all the 435 members of the House of Representatives and 34 of the 100 Senators. The stakes are high for President Trump. If the Democrats win the majority in the Senate and gain more seats in the House, greater pressure on his Administration could well hurt the US dollar.

In the meantime, uncertainty revolves around trade disputes with both China and the European Union, although there is hope that agreements will soon follow a north American accord.

Due to this uncertainty, the Fed "may opt for a dovish rate-hike on September 26", contends David Song, who is a currency analyst for DailyFX.