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Friday October 22, 2004 - 14:39:10 GMT
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Forex: FOMC SF Fed President Yellen On The Dollar

FOMC SF Fed President Yellen On The Dollar

Yellen's speech in San Francisco late Thursday is in the spotlight as she again mentioned the dollar. Here is what she said in the context of describing factors that were depressing the intermediate-term real Fed funds rate. "Another factor that may be working in the same direction is the dollar, which has remained relatively high despite our large and growing trade deficit. A high dollar makes imports less expensive for us and makes our exports more expensive abroad, thereby undermining the demand for domestic output. In order to offset this drag on demand for domestically produced goods and services, interest rates must be lower than would otherwise be necessary to produce full employment in our economy. A relatively high dollar depresses the equilibrium real rate."

Context is paramount in this quote...something both US presidential campaigns ignore in parsing each sides quotes. Yellen is making observations not prescribing policy solutions, like a weaker dollar. She is observing that the dollar is relatively high to the size of the external imbalance full stop. She is also observing that the high dollar depresses US domestic activity and hence helps generate lower than historical average real Fed funds rate. However, on September 09, in Q&A she said if the dollar's value remains steady it will widen the US current account deficit even more (already alarmingly wide). She said any turnaround in the c/a deficit has to involve the dollar, but also stressed her time horizon was 10-20 years. It would appear that Yellen believes the dollar has a role to play in trade adjustment and over time it will depreciate. Is she keen on talking the dollar lower every chance she gets? This is doubtful. And it would be wrong to conclude that she would like a weaker dollar so that the real Fed funds intermediate-equilibrium rate would be reached sooner and at something closer to the historical norm.

Still it is curious that Yellen's (and McTeer's last week) comments on the dollar have not generated any clarification from the US Treasury. In the days of Rubin and Summers one would have seen immediate statements from the US Treasury reminding markets that dollar policy is sole purview of the Treasury Secretary and it alone speaks on dollar policy. Yellen is freelancing here and Treasury is not too concerned. Then again why should it be concerned? The dollar is not in a freefall based on Yellen's (or McTeer's) recent remarks suggesting the dollar needs to depreciate to facilitate trade adjustment. This Treasury is most keen on markets setting exchange rates and orderly moves in FX are likely to be ignored even if they happen after comments by FOMC members on the dollar and the trade deficit and traders sell the US currency. But the notion that the Bush administration or even freelancing FOMC members are eager to embrace a weak dollar to boost growth and shrink the trade gap is misguided. Frankly it would be irresponsible given the slippery slope it presents when the US needs $600bln a year in foreign savings to fill the gap between savings and investment. Officials risk managing an orderly dollar decline and markets turning it into a stampede, with official backing. And a stampede of dollar selling would risk sending US bonds and stocks lower, accelerating a US slowdown. Remember in two weeks is a presidential election. The dollar does not need to be a major problem or distraction in the campaign and economy with a last minute effort by the admin to talk down the dollar or use surrogates like Yellen and McTeer.

Then there is European thinking on the rise in euro/dollar. Yes it is a hedge against higher oil prices and commodities generally. But export-led growth is still the dominant strain in Europe and exports are growing fastest to China and the US (recall yuan is pegged). So this sword cuts two ways. ECB officials are happy with the Boca Raton accord that essentially said enough to euro/dollar appreciation and more support for dollar depreciation versus Asia's currencies. Still Euro Zone officials (central bankers and finance ministers) for the most part remain confident that the current expansion will continue despite the rise in the price of oil. And the confidence in the recovery is considerably higher than it was in February when euro/dollar reached 1.29. So it follows that ECB and Eurogroup protests over euro/dollar will not be seen until much higher levels...though this could change if the pace accelerates quickly and causes disruptions in asset markets).

David Gilmore


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