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FX Briefing - The end of the “strong dollar” doctrine

FX Briefing 8 October 2010



Prospect of Fed policy easing and yuan conflict put dollar under pressure

ECB shrugs off euro appreciation, confirms policy stance

Tensions should ease with U.S. midterm elections, FOMC meeting and G20 summit


The end of the “strong dollar” doctrine


The US dollar is losing further ground on the foreign exchange markets. EUR-USD succeeded in briefly going beyond 1.40 on Thursday, sterling reached a 7-month high of 1.60 and, at almost 1.00, AUS-USD is at its highest level in 28 years. Despite the surprising cut in interest rates by the BoJ and the decision to implement further quantitative easing measures in the total amount of 35 trillion yen, USD-JPY has fallen below the “intervention threshold” of 83. USDCHF is posting new all-time lows every day.


Monetary authorities in the emerging markets are fighting the upward pressure on their currencies by intervening on the forex markets and using capital movement controls. IMF managing director Dominique Strauss-Kahn warned against using currencies as weapons and Brazil’s president Luiz Inácio Lula da Silva spoke of a currency war.


The Rubin doctrine that a strong dollar was in the interest of the US seems to have become obsolete. In the run-up to the autumn meeting of the IMF and the World Bank as well as the G20 meetings in October and November, the US has been putting greater pressure on China to allow a substantial appreciation of the Chinese currency. A weaker dollar would help the US economy to regain competitiveness and promote growth and employment in the US.


The exchange rate dispute with China is nothing new but from a US perspective it has become a much more urgent political issue than in previous running out of political tools to get the economic engine going. The strained public budget provides for very little leeway in financial policy. For another, the government is trying to gain favour among the electorate ahead of the congressional elections on 2 November.


Unlike in earlier years, the US administration’s efforts to build up pressure on China are now receiving massive support from monetary policy. Since the last open market committee meeting there are growing signs that the US central bank is preparing further quantitative easing measures. Although there are widely diverging views as regards “QE2” even within the ranks of the Fed itself, the markets are almost certain that a substantial securities purchase programme will be launched on 3 November.


The expectation of such a flood of liquidity is pushing US interest rates to new lows and clearly weakening the US dollar. This effect is even aggravated by the fact that – unlike in the US – monetary policy in most other economies is meanwhile more inclined towards tightening rather than easing the monetary reins. This applies to most emerging markets but also to a number of industrialised countries and, in essence, to the euro-zone as well.


From a European point of view, this is something of a dilemma. With respect to China, Europe is pulling in the same direction as the US. The EU, too, has long been urging that the yuan’s undervaluation be corrected. As long as this does not happen, however, and China and the other Asian “dollar block” countries prevent an appreciation of their currencies via controls on capital movements and interventions on the forex markets, it is the European currencies that will have to bear the brunt of the upward pressure.


The effect of the expansionary US monetary policy on the European currencies is even stronger because the ECB – in view of signs of recovery in most major EMU economies – seems to be moving in the opposite direction. During Thursday’s press conference, ECB president Jean-Claude Trichet did not comment on the exchange rate trend and once again confirmed the central bank’s fundamental intention to continue exiting the unconventional measures. Even the increase in interest rates on the EMU money market, prompted by the outflow of excess liquidity in the last few weeks, does not appear to be much of a problem for the ECB. Sound economic data from the EMU members such as strong new orders and production figures in Germany for the month of August are adding their bit to the upward pressure on the euro.


The weakness of the US dollar is probably here to stay for a while. The crucial dates are all in November, i.e. the US congressional elections, the FOMC meeting and the G20 summit in Seoul. Despite the belligerent statements of the last few days, we do not expect to see a major currency devaluation race. We believe that China will make some concessions in the negotiations with the USA and the EU. China is still rather stubborn at the moment. Prime minister Wen Jiabao points to significant risks for what he considers to be a low-margin Chinese export industry and the consequential risks for growth, employment and social stability in China. On the other hand, China wants to have greater influence in the IMF, and the price it will have to pay for this is cooperation.


We have furthermore gained the impression that market expectations as regards US monetary policy are vastly exaggerated. For some time now we have noticed that the warnings of a double dip and deflation have become less audible: the economic recovery in the US is continuing, with third-quarter growth likely to amount to around 2 %, bolstered by private consumption, capital investments and foreign trade. Although the employment trend is anything but satisfactory the current situation would not call for dramatic emergency measures. Taking the sceptics in the FOMC into account, we would therefore rather expect to see prudent and circumspect action.


This is why we believe that the pressure on the US dollar will continue in the next few weeks. It is likely that the EUR-USD rate will rise to well above 1.40. From around the beginning of November, however, the sabre rattling could subside again and the dollar regain lost ground.


Stephan Rieke +49 69 718-4114


Economics Department

+49 69 718-3642

[email protected]

Foreign Exchange Trading

[email protected]

Matthias Klein

+49 69 718-2175

Matthias Grabbe / Klaus Näfken

+49 69 718-2146 / -2683


This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.


The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results.


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All rights reserved. Please mention source when quoting from it.





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