Given the complexities of interconnected global economies, it’s rare to see policy interventions play out cleanly. We argue “if we do X, I expect to see Y,” but it doesn’t often work out that way.
That’s why the linkage between the more dovish U.S. Fed and the recent decline in the dollar relative to other major currencies is notable. Given the pressures on our trade balance from the strengthening dollar, mine was among the voices arguing that the dollar was one reason to be extremely cautious about rate hikes (higher interest rates usually strengthen your currency, though not always…read on). Last year, net exports subtracted 0.6 of a percentage point from real GDP growth and manufacturing job growth slowed sharply: factory jobs were up 208,000 in 2014 compared to 26,000 last year.
As the Bloomberg figure shows, the value of the dollar moves roughly with the odds of a higher Fed funds rate. The decision not to raise at this week’s meeting and the somewhat dovish shift in their statement, which referenced global risks to the US outlook, contributed to a sharp decline in the dollar.
In my view, that’s smart policy at work.
Interestingly, it’s not working out quite that way in other parts of the globe, as the WSJ points out in a cover story this AM. Japan’s currency, despite aggressive rate cuts that have taken their central bank rate into negative territory, is up 8 percent against the dollar.
Why is a pause in our normalization campaign having the predicted effect on our currency versus the experience of Japan and others? It could be that bank rates are so low in so many countries these days that, as the Journal puts it, they’re “cancelling each other out.”
In other words, X won’t always lead to Y. But at least in our case of the Fed and the dollar, the usual relation seems to be holding.