Volatility wise, it was a relatively quiet day in the forex market. USD/JPY extended its losses but the greenback recovered against euro, sterling and other major currencies. The rallies in the Australian and New Zealand dollars were the strongest with both currencies experiencing their biggest one-day rally in 3 weeks versus the dollar. While there were no US economic reports released today, the rebound in stocks supported the steadier price action. Better than expected Chinese trade also helped fuel the recovery in AUD and NZD.
With that said, the big story in the markets today was President Trump’s comments on the dollar. In a series of tweets, he said, “As your President, one would think that I would be thrilled with our very strong dollar. I am not! The Fed’s high interest rate level, in comparison to other countries, is keeping the dollar high, making it more difficult for our great manufacturers like Caterpillar, Boeing, John Deere, our car companies, & others, to compete on a level playing field. With substantial Fed Cuts (there is no inflation) and no quantitative tightening, the dollar will make it possible for our companies to win against any competition. We have the greatest companies in the world, there is nobody even close, but unfortunately the same cannot be said about our Federal Reserve. They have called it wrong at every step of the way, and we are still winning. Can you imagine what would happen if they actually called it right?”
Investors are worried that by expressing a preference for a weaker dollar, President Trump is hinting that he could order the Treasury to intervene in the currency. This would be similar to his actions last week where he called China a currency manipulator on twitter and a day later, the Treasury made the label official. Could President Trump devalue the dollar? Certainly. Just last month he said he “could do that in two seconds if I wanted,” but any intervention could backfire.
Intervening in the Dollar is a Bad Idea
President Trump will argue that by devaluing the dollar, he’s making US exporters cheaper and foreign profits of American companies more valuable in US dollar terms.
But dollar intervention is a bad idea because it drives up prices, creates more volatility in the markets and makes the Fed’s job more difficult. If Trump’s primary goal is to pressure the Fed to cut interest rates further, he’s accomplished that by escalating the trade war with China. Markets collapsed, global growth will slow and investors are looking for two more rate cuts this year.
If Trump devalues the dollar, stronger foreign profits could be offset by lower stock valuations and weaker demand at home.
Also intervention rarely works if its not coordinated with the central bank. If the Fed sterilizes the intervention, the impact could be limited. If stocks crash, investors will flock to the safety of US dollars anyway.
If intervention move is aimed at leveling the playing field with China, the US can’t afford to intervene because China has deeper pockets. The Chinese government has $3 trillion in reserves to prevent the currency from weakening. US intervention on the other hand is funded by the Exchange Stabilization Fund, which has a buying power of $100 billion. Trump could allocate more funds but that would require the approval of Congress.
Judging from the price action in the dollar today and the move in US stocks, investors are not worried about intervention risk. They feel that the chance is low because its unprecedented and dangerous but Trump likes to buck convention and could find ways to push this through.