Old gold bugs know the old plaint, “gold, gold, you’re makin’ me old.” Well, today’s version is “dollar, dollar, you’re makin’ me holler!”
I’ll be brief—I’ve got something longer on this coming out soon—but I’ve been struck by both the recent jigs and jags in the dollar and other currencies. A central reason for those movements is that it’s awfully hard to figure out what the Fed is up to, as I’ll recount in a moment.
First, currency movements have been following some unusual patterns – for example, rising after central bank rate cuts (Japan, Australia; typically, we expect currency values to fall after rate cuts) and jumping around here in the US with more volatility than usual, highly sensitive to winks and nods from our Fed about their next rate move.
The WSJ this AM featured a story about the falloff in the dollar year-to-date, which opened thusly:
Federal Reserve officials are trying to signal that another rate increase is likely while at the same time questioning whether the economy can expand fast enough to justify lifting them much beyond that.
It is a confusing combination that is sapping the Fed’s influence over markets.
Then, a few minutes ago, the Journal tells me that the dollar’s rallying on the suspicion that when the minutes from the Fed’s July meeting come out, they’ll be leaning into a rate hike later this year. So the Fed is like, “we’re gonna raise rates,” but the extent to which market investors believe them are changing on a daily basis.
Actually, an hourly basis. Check out the summersault in the dollar index upon the release of the Fed’s minutes. Basically, it goes from “they’re gonna raise!” to “no they’re not!” to “maybe…who knows?!” all in the course of a few New York minutes.
In fact, it’s all a muddle. Read this interview with Fed governor John Williams. The thrust of his argument is that interest rates need to go up as the Fed’s been “adding enormous policy accommodation over the past several years” and, even while they’ve long been missing their inflation target on the downside, there’s a risk of getting “significantly behind the curve.” At one point he makes a distinction between “letting up on the gas” and “tapping the brakes,” one that left me and I suspect others going “wait…wuh?”
But Williams’ own work, and his isn’t the only that finds this, suggests that the Fed’s so called neutral long-term rate—the rate consistent with full employment and stable prices—is zero right now, meaning they haven’t been enormously accommodative. In that same interview, he seems to be reaching to square these contradictions, by suggesting that the Fed’s current model—targeting 2% inflation, a Fed funds rate of ~3%, and an unemployment rate of ~5%–is not reliable and that they should maybe move to a different targeting regime, like price-level or nominal GDP targeting. Both of those would lead the Fed to take rate hikes way off the table right now.
The point isn’t to pick on Williams or anyone else who’s clearly trying to figure out what’s going on, or more precisely, what’s changed in the basic macro-economic relationships such that prior guideposts are no longer reliable. The problems arise because of a level of confidence that these prominent figures believe they must exude. Part of their model is providing guidance and “we’re not sure what’s going on” is considered to be…um…a bit weak in that regard.
But the cognitive dissonance–asserting X despite the fact that my model and the evidence suggest Y–is leading to an incoherence that’s predictably generating volatility.
I’m less worried about investors than about workers. And for all the muddle, the one thing that seems clear is that the risks to the economy and particularly the labor market—which is generating solid job growth and even some wage gains (for which we should all give Chair Yellen and the Fed serious credit)—remain “asymmetric:” there’s a greater risk of needlessly slowing non-inflationary growth than there is of inflation accelerating. The notion of being “behind the curve” in that regard seems indefensible.
Like I said, more to come on this. As Williams’ comments re alternative targeting suggests, this is an important time to be thinking about pretty different models of how the world works.