Around the world, the soaring dollar is hurting economies, upending financial markets and wreaking havoc in its wake. Some central banks are now backtracking.
On Friday, the People’s Bank of China became the latest central bank to intervene, attempting to slow the pace of the renminbi’s depreciation against the dollar. The Japanese Ministry of Finance had started to intervene a week before. The Reserve Bank of India tried to slow the depreciation of the rupee, and the Bank of England was forced to hint at monster rate hikes to come after the pound fell to multi-decade lows.
Which may seem strange to some. After all, countries like China have in the past been accused of artificially preventing their currencies from stronger. Indeed, governments often like weaker currencies. It makes exporting more attractive, attracts more foreign tourists and can be a relatively inexpensive way to boost a country’s competitiveness.
But only up to a certain point, and as long as the movement is contained. And the 2022 dollar rally was anything but. The resulting rampant currency weakness elsewhere can lead to both capital flight and future inflation as imports become more expensive, forcing central banks to tighten more than they had expected.
It’s no wonder, then, that rumors are swirling around at high speed about a new “Place Accordlike the 1985 agreement between the world’s major economies to organize a significant depreciation of the US dollar to mitigate the negative impact on many other countries.
More recently, in February 2016, we witnessed a so-called “Shanghai Agreement‘” after the dollar took a massive run that ultimately triggered months and months of capital flight out of China and threatened global growth and financial stability.
Although no formal pact was announced – unlike in 1985 – the Fed quietly backed off from its hike cycle. In December 2015, the Fed’s “dot chart” promised four quarter-point hikes in 2016. Instead, the Fed waited until the end of the year and only hiked one. time. The greenback began to weaken from the end of February and the financial markets, which had experienced a very bad start to 2016, calmed down.
We have been inundated in recent days with questions from customers asking if a repeat is now likely. As global policymakers gather in mid-October for IMF meetings in Washington, DC, is a new Plaza Deal surely upon us? Yes, the most important step for any new dollar deal is for the Fed to halt its planned hikes. Without it, nothing will work. But are Fed officials surely ready, given the damage a strong dollar is now causing elsewhere?
No chance. As Tom Smallthe Fed will not back down.
First, while the strong dollar may lead to higher inflation in other economies, it does not lead to much lower inflation in the United States. Since many goods and services around the world are denominated in dollars, the prices of US imports fall much less than you might think when the dollar strengthens. Moreover, the United States is a rather inward-looking economy; trade and its impact on prices is almost never a big enough factor in the macroeconomic outlook.
And most importantly, the US economy is still far too strong for the Fed to change course just for the rest of the world. This is not 2016, when US inflation was below 2% for most of the year. With inflation at 8-8.5% for much of this year, the Fed simply has no room to back down.
And while there are signs that the rest of the world is hurting, consider the recent slew of US data. Core PCE inflation is close to 5% and the latest report was stronger than the consensus. Consumption and personal spending releases a few days ago surprised on the upside.
Yes, housing is in trouble, but the Fed has brushed that aside and focused almost exclusively on the scorching labor market, which is still creating nearly 400,000 jobs a month lately.
Nor are there any signs of a marked slowdown in the labor market. While the last jobs report was four weeks ago, initial jobless claims have been declining for several weeks and remain remarkably low. And without evidence of a turn, the Fed will stick to its course. The dot chart was signaling another 75bps rate hike in October and another 50bps in December, and it’s hard to see them changing their minds due to the economic troubles outside the U.S. .
And no one can accuse them of hiding their intentions. Even as UK financial markets saw unprecedented volatility last week, Fed speaker after Fed speaker struck a hawkish tone.
Fed Vice Chairman Lael Brainard warned of the dangers of withdrawing too soon from hikes. President of San Francisco Marie Daly, often seen as a dove, pointed to fighting inflation as the Fed’s top priority right now. The St. Louis Fed James Bullard minimized the impact of the strong dollar. The Cleveland Fed Chairman was even more adamant Loretta Mesterwho said that even a recession would not prevent the Fed from rallying to restore price stability.
These are fighting words – and they suggest a U-turn on politics is not in the cards, no matter how much the dollar strengthens in the short term.
Over the next few weeks, many policy makers around the world will no doubt be flying to DC and pleading for respite. But the Fed will be sympathetic but unmoved. To anyone hoping for a new Accord Plaza, all we can say is: good luck.