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Thursday May 8, 2008 - 15:03:22 GMT
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Forex Blog - US Treasury, Fed Embrace Dollar...Trichet's Tin Ear

The FT story (below) on Europe and US officials (Treasury, Fed, Eurogroup and ECB) unite on a stronger dollar came out last night and had all the hallmarks of a Greg Ip-like story from the halls of monetary power to deliberately get the dollar up versus the euro and the ECB meeting today (Governing Council statement) would be the exclamation point behind the new (or new old message assuming April G7 meeting really was important). Well the market did the right thing – it pressed the bet (sold euro/dollar ahead of EC press conference. What did Trichet and the GC do? Nothing. Rien. Nada. Trichet’s tin ear was once again on display – there is no material change in our assessment of inflation risks since the April meeting and it would take a US litigation lawyer to prove the assessment of growth changed one iota.  All Trichet had to do today was wink once at growth and blink once at inflation and euro/dollar would be under 1.50.  Should we blow off the FT article (Krishna Guha is the new Greg Ip in Washington, as is CNBC’s Leisman)? No I don’t think so even if Trichet did not play along.

I can say confidently that the US view of the dollar indeed changed ahead of the April G7 meeting which laid the foundation for the new wording in the communiqué. How did it change? Well the Treasury and White House felt that the weak dollar was doing all it could to help growth via net exports but continued weakness risked turning a silk purse into a sow’s ear, especially in light of the (then) tight correlation between the dollar and oil (commodity) prices.  But also there was a realization that the economic fundamentals driving the dollar lower were in transition – the US economy was likely to experience a brief and shallow recession (I still differ on this view) allowing the Fed to pause, while the Euro Zone high frequency data were showing greater signs of a slowdown and no decoupling which in time would allow the EC to stand down on inflation (after today we are still waiting).

Now on the speculative side of the story I would say it is a safe bet that the White House and Treasury do not want a sharply higher dollar – in a word stabilization. But it is also clear that off multi-decade lows for the dollar, stabilization also means there is scope for the dollar to strengthen.  I will speculate a little more here and assume that the Fed reached a similar conclusion and this played into its decision to hint at a pause in rate cuts April 30.

But I also know (no speculation) that the Bush administration finds currency intervention almost repugnant (markets not governments are the best arbiters of prices) – though never say never.  Indeed using the baseball metaphor not intervening in the currency market in eight years is like pitching a perfect game.  On the other hand currency intervention is far more appealing to both Eurogroup and ECB than to both the US Treasury and Fed (of all the parties involved in FX intervention the Fed goes along for the ride on this one).

Does today’s hawkish press conference and statement from the ECB and ECB President today mean European central bankers and finance ministers are not on the same page regarding the euro and dollar?  Hardly. They both want more than what US officials want – beyond stabilization and a sustained downtrend in euro/dollar.  However, they differ on the scope now to signal sufficient Euro Zone economic weakness to close the circle around the currency…Eurogroup thinks the economy is showing significant signs of economic weakness to allow the ECB to stand (maybe step) down on inflation in favor of growth.  Predictably (despite the FT distraction today) the ECB is still Zeus atop Mount Olympus, the great protector of price stability, punishing those demanding a growth-oriented monetary policy.

It’s a it ironic that the US has embraced the notion (after several years of urging) to put an end to the dollar’s decline and yet the ECB is a no show when it comes to introducing downside risks for interest rates in the Euro Zone.  Trichet is about as in touch with his G7 cohorts on policy as Marie Antoinette was with the hungry masses of Paris several hundred years ago.  But instead of the “Let them eat cake” all Trichet can say in a Marie Antoinette vein is “Let them wait.”  Or for the truly cynical “We want our cake and eat it too.”

David Gilmore




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