Central bankers around the world will tell you they make monetary policy for the countries where they reside. But if they are being honest, they’ll also tell you how much central banks in other countries affect their own strategies.
Right now, central banks other than the Federal Reserve are helping to drive the U.S. dollar higher, a fact the Fed has to consider as it ponders whether to continue raising rates. At a time when some economists are questioning the durability of the U.S. recovery, the divergent directions of other central banks could force the Fed to slow, or even alter, its own course.
Mario Draghi, president of the European Central Bank, last week signaled that the ECB will make additional efforts to ease monetary conditions in Europe. With U.S. rates already higher, the statement was an invitation to investors to buy higher-yielding, dollar-denominated assets and dump their euros. For good measure, Draghi emphasized the ECB’s determination. “We don’t give up,” he said.
“You must not under-estimate this sentence,” Erik Nielsen, chief economist at UniCredit, wrote in a research note. “What Draghi communicated was that ... it’s ‘the pedal to the metal.’ ”
And Draghi’s not alone. The Bank of Japan is still trying to revitalize the Japanese economy, and the People’s Bank of China is doing its part to combat the slowdown in Chinese growth. In other words, they are telegraphing that investors would do well to dump their yen and renminbi, too.
That might not make Fed Chair Janet Yellen give up the Federal Reserve’s plan to slowly normalize interest rates after nearly a decade, but it might give her pause at a time when economists are questioning the resilience of the U.S. economy. A stronger dollar makes U.S. exports more expensive, and improves the competitive position of other countries.
Goldman Sachs estimates that the combination of share price declines and the further appreciation of the U.S. dollar is equivalent to about 70 basis points — 0.7 percentage points — of Fed tightening. And the Fed only tightened 25 basis points in December. Put another way, financial markets are doing for the Fed what the Fed expected, as recently as a month ago, to be doing for itself.
Expectations that the Fed would continue its monetary tightening in March are now much less certain thanks to the international developments since its December meeting. Analysts at Goldman Sachs expect the Fed, in the statement it customarily issues after its policy meetings, will this week explicitly acknowledge that the risks to its outlook for the U.S. economy have worsened as a result of financial market chaos and the U.S. dollar’s strength.
Stephen Jen, founder of SLJ Macro Partners, said the U.S. currency’s strength has derailed the Fed’s plans before, and there’s no reason to believe it can’t happen again.
“The Fed may push back [rate hikes] on the dollar, as they did at the March, June, and September FOMC meetings in 2015,” Jen said in an email. “We will see.”
The dollar’s strength now looks to be a durable story, carrying on well into 2016, mainly thanks to economic weakness outside the United States. On a trade-weighted basis, the dollar appreciated about 10 percent in 2015, and another 2 percent so far this year, according to data published by the St. Louis Federal Reserve Bank.
Across the United States, major exporters are acknowledging the reality. Martin Schroeter, chief financial officer at IBM, said the dollar’s strength will take its toll again this year. “At current spot rates, we would expect a significant impact to revenue and profit again in 2016,” Schroeter said in a Jan. 19 conference call with analysts, according to Bloomberg News.
U.S. exports dropped 7.1 percent in November 2015 from the same month the year prior, according to the Commerce Department. Another fall seems likely for December, when the Institute for Supply Management recorded a sharp drop in demand for U.S. manufactures as a result of the strong dollar.
The rest of the world is taking solace from the stronger dollar.
Brazil headed into 2015 worried that the economic slowdown in China would slow the torrid pace of grain exports to China, but the opposite happened, because Brazilian producers were able to pick up market share from their American competitors. The government even had to auction off corn from its own stocks because China, Japan, Vietnam and South Korea snapped up so much Brazilian product that its beef and pork producers didn’t have enough to feed their stock.
“The weaker currency against the dollar has saved the Brazilian farmers’ butts,” said Michael Cordonnier, founder of Soybean & Corn Advisor and a specialist on Brazilian agriculture. “And that’s strictly due to the currency.”