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Tuesday October 19, 2010 - 14:18:12 GMT
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Forex Blog - Dollar Détente (FXA)

Dollar Détente


US Treasury Secretary Geithner finally was heard on the USD and in the context of recent market moves (huge decline)…he did not chant the dollar mantra but he did state emphatically that the US is not devaluing the dollar (maybe the Fed is) and it is working hard to retain confidence in the currency.  I think we can conclude that the US Treasury is doing its part to defuse the potential for a currency war and registering an alarm…the dollar has fallen fast enough if not far enough against everything but the yuan.  And even on this front, where the threat of a currency war is greatest, the US Treasury last Friday decided to postpone a report to Congress on the yuan to allow for more bilateral and multilateral discussions with the Chinese in upcoming G20 meetings (one this Friday and Saturday and the other in November and both in South Korea) and noted that recent appreciation in the yuan is welcomed and helpful (a pace that might meet US demands if maintained is how I read it).  And it is also noteworthy that the PBOC today hiked key rates 25bps (took the 1-year lending rate at 5.56%) and was the first increase since 2007.   Surely the PBOC would not be raising rates and allowing for a faster rate of appreciation (it has slowed in recent days) unless it was worried about domestic overheating and would suggest that a higher yuan is appropriate (I don’t view a rate hike as a substitute for yuan appreciation, but a compliment).  I can’t help but conclude that all of these events are connected…not planned in mutual fashion but indeed represents a real attempt by the US and China to tamp down currency tensions ahead of G20.  I call it Dollar Détente. 


I know that some countries and groups of countries like the EZ are eager to see G20 agree to try to stabilize FX (read stabilize the dollar) but this is not in the cards from a US perspective.  First and foremost the Fed is really indirectly determining where the USD trades with its deployment shortly of QE2.  The US Treasury may think the USD has fallen fast enough and perhaps far enough (except versus the yuan) but this could prove irrelevant for markets as QE2 trumps official jawboning and if ever deployed currency intervention.  The most US Treasury can achieve with well timed signals like the one from Monday in California is to slow the dollar’s decline – introduce 2-way risk – but not reverse the trend or stabilize the dollar…not when the Fed is ready to embark on open-ended quantitative easing (no way the market can discount this given that it can and will be adjusted as more data points are received…could be a lot less or a lot more than say $100bln a month which Fed’s Lockhart seemed to imply was a reasonable starting point today.  Frankly there is no way the Fed is going to limit QE2 to some USD path.  And frankly the Chinese has an argument that QE2 is every bit a form of FX manipulation as is Chinese currency intervention selling CNY for USD, if less direct. 


I think US Treasury has had an epiphany on the dollar decline.  It now recognizes as I have above that QE2 is a very powerful downdraft for the USD ahead and the only way to offset or delay some of the effect from the Fed printing more money is to go on record with a verbal defense of the dollar as a reserve currency as happened Monday with the Treasury Secretary’s remarks (as best I can discern they were not prepared remarks but extemporaneous remarks and Geithner spoke on the dollar in an unprompted fashion…deliberately).    I don’t believe the US Treasury is ready to agree to joint USD currency intervention at G20 in South Korea Friday and Saturday, but I would also not exclude this kind of response from the policy options down the road…key for US engaging intervention is dollar decline disrupts asset prices (Treasuries or stocks). 


I also think it is pretty clear that Geithner finds the strong dollar mantra unhelpful (as has every Treasury Secretary since Rubin with O’Neil the only one to publicly question the mantra and regrettably so) and I may have been “correct” in noting last week on FXA On-line that it was euthanized…Dr. Kevorkian was seen on the third floor of US Treasury building…clearly ECB President Trichet was not cc’d on the email as he continues to chant the mantra on behalf of US Treasury officials.


Dollar concerns outside the US are ubiquitous…even Canada is worried – see BOC statement today on FX market volatility.  Brazil raised taxes on foreign fixed income investments on Monday.  South Korea’s government is moving in a similar direction.  Let[‘s face it the falling dollar is taking activist currency policy from intervention (limits reached in reserve accumulation and now distortionary for interveners and non-interveners as managers diversify into gold and non-USD bonds…ask Japan on China JGB purchases) to capital controls.  Capital controls in emerging markets might be a first best alternative for more USD accumulation in the near-term by reserve managers, but it is problematic over the long run and creates other unintended consequences.  I think the US Treasury gets this and we should expect to hear more FX messages ahead from Geithner.


However, with the Fed QE2 not yet launched and open ended, again I think this trumps US Treasury concerns on the dollar and capital controls in places like Brazil and South Korea.  Yes we are due for USD bounce into G20, but a reversal of trend?  I think not.


David Gilmore  



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