The Prospects of a Weaker Dollar Policy- RIA Pro
This version, for RIA Pro subscribers, contains a correlation table at the end of the article to help better quantify short and longer term relationships between the dollar and other financial assets.
“Let me be clear, what I said was, it’s not the beginning of a long series of rate cuts.”- Fed Chairman Jerome Powell -7/31/2019
“What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world….” – President Donald Trump – Twitter 7/31/2019
With the July 31, 2019 Fed meeting in the books, President Trump is up in arms that the Fed is not on a “lengthy and aggressive rate-cutting” path. Given his disappointment, we need to ask what else the President can do to stimulate economic growth and keep stock investors happy. History conveys that is the winning combination to win a reelection bid.
a President’s most effective tool to spur economic activity and boost stock
prices is fiscal policy. With a hotly contested election in a little more than
a year and the House firmly in Democratic control, the odds of meaningful
fiscal stimulus before the election is low.
fiscal support, a weak dollar policy might be where Donald Trump goes next. A
weaker dollar could stimulate export growth as goods and services produced in
the U.S. become cheaper abroad. Further, a weaker dollar makes imports more
expensive, which would increase prices and in turn push nominal GDP higher,
giving the appearance, albeit false, of stronger economic growth.
article, we explore a few different ways that President Trump may try to weaken
Weaker Dollar Policy
to write this article came from the following Wall Street Journal article: Trump Rejected Proposal to Weaken Dollar through
In particular, the following two paragraphs contradict one another and lead us
to believe that a weaker dollar policy is a possibility.
On Friday, Mr. Kudlow said Mr. Trump “ruled out any currency intervention” after meeting with his
economic team earlier this week. The comments led the dollar to rise slightly
against other currencies, the WSJ Dollar index showed.
But on Friday afternoon, Mr. Trump held out the possibility that
he could take action in the future by saying he hadn’t ruled anything out. “I
could do that in two seconds if I wanted to,” he said when asked about a
proposal to intervene. “I didn’t say I’m
not going to do something.”
Based on the article, Trump’s advisers
are against manipulating the dollar lower as they don’t believe they can
succeed. That said, on numerous occasions, Trump has shared his anger over
other countries that are “using exchange
rates to seek short-term advantages.”
As shown below, two measures of the U.S.
dollar highlight the substance of frustrations being expressed by Trump. The DXY
dollar index has appreciated considerably from the early 2018 lows but is still
well below levels at the beginning of the century. This index is inordinately
influenced by the euro and therefore not 100% representative of the true effect
that the dollar has on trade. The Trade-weighted dollar which is weighted by
the amount of trade that actually takes place between the U.S. and other
countries. That index has also bounced from early 2018 lows and, unlike DXY, has
reached the highs of 2002.
Data Courtesy Bloomberg
Trump’s Dollar War Chest
The following section provides details
on how the President can weaken the dollar and how effective such actions might
Currency Market Intervention
Intervening in the currency markets by
actively selling US dollars would likely push the dollar lower. The problem, as
Trump’s advisers note, is that any weakness achieved via direct intervention is
likely to be short-lived.
The US economy is stronger than most
other developed countries and has higher interest rates. Both are reasons that
foreign investors are flocking to the dollar and adding to its recent appreciation.
Assuming economic activity does not decline rapidly and interest rates do not
plummet, a weaker dollar would further incentivize foreign flows into the
dollar and partially or fully offset any intervention.
More importantly, there is a global dollar
shortage to consider. It has been estimated by the Bank of International
Settlements (BIS) that there is $12.8 trillion in dollar-denominated
liabilities owed by foreign entities. A stronger dollar causes interest and
principal payments on this debt to become more onerous for the borrowers. Dollar
weakness would be an opportunity for some of these borrowers to buy dollars, pay
down their debts and reduce dollar risk. Again, such buying would offset the
Treasury’s actions to depress the dollar.
Instead of direct intervention in the
currency markets, Trump and Treasury Secretary Steve Mnuchin can use speeches
and tweets to jawbone the dollar lower. Like direct intervention, we also think
that indirect intervention via words would have a limited effect at best.
The economic and interest rate fundamentals
driving the stronger dollar may be too much for direct or indirect intervention
From a legal perspective intervening
in the currency markets is allowed and does not require approval from Congress.
Per the Wall Street Journal article, “The 1934 Gold Reserve
Act gives the White House broad powers to intervene, and the Treasury maintains
a fund, currently of around $95 billion, to carry out such operations.” The author states that the Treasury
has not conducted any interventions since 2000. That is not entirely true as
they conducted a massive amount of currency swaps with other nations during and
after the financial crisis. By keeping these large market-moving trades off the
currency markets, they very effectively manipulated the dollar and other
Hounding the Fed
aggressively chastised Fed Chairman Powell for not cutting interest rates or
ending QT as quickly as he prefers. Lowering interest rates to levels that are closer
to those of other large nations would potentially weaken the dollar. The only
problem is that the Fed does not appear willing to move at the President’s pace
as they deem such action is not warranted. We believe the Fed is very aware
that taking unjustifiable actions at the behest of the President would damage
the perception of their independence and, therefore, their integrity.
this problem, Trump could take the controversial and unprecedented step of
firing or demoting Fed Chairman Powell.
In Powell’s place he could put someone willing to lower rates
aggressively and possibly reintroduce QE. These steps might push financial
asset prices higher, weaken the dollar, and provide the economic pickup Trump
seeks but it is also fraught with risks. We have written two articles on the
topic of the President firing the Fed Chairman as follows: Chairman
Powell You’re Fired and Market
Implications for Removing Fed Chair Powell.
It is not
clear whether the President can get away with firing or even demoting Chairman
Powell. We guess that he understands this which may explain why he has not done
it already. If he cannot change Fed leadership, he can continue to pressure the
Fed with Tweets, speeches, and direct meetings. We do not think this strategy
can be effective unless the Fed has ample reason to cut rates. Thus far, the
Fed’s mandates of “maximum employment, stable prices, and moderate long-term
interest rates” do not provide the Fed such justification.
Getting Help Abroad
One of the core
topics in the U.S. – China trade talks has been the Chinese Yuan. In
particular, Trump is negotiating to stop the Chinese from using their currency
to promote their economic self-interests at our expense. As of writing this,
the U.S. Treasury deemed China a currency manipulator. Per the Treasury: “As a result of this determination (currency
manipulator), Secretary Mnuchin will engage with the International Monetary
Fund to eliminate the unfair competitive advantage created by China’s latest
actions.” Said differently, the U.S. and other nations can now
manipulate their currency versus the Chinese Yuan.
It is plausible that Trump might pressure other countries, including our allies in Europe and Japan as well as Mexico and Canada, to strengthen their respective currencies against the dollar. Trump can threaten nations with trade restrictions and tariffs if they do not comply. If tariffs are enacted, however, all bets are off due to the economic inefficiencies of tariffs or trade restrictions. To the President’s dismay, such action weaken the economy and scare investors as we are seeing with China.
trade actions, trade-related actions, or trade agreements might work to weaken
the dollar, but such tactics would require time and pinpoint diplomacy. Of all
the options, this one requires longer-term patience in awaiting their effect
and may not satisfy the President’s desire for short-term results.
Before summarizing we leave you with one important thought and certainly a topic for future writings. Globally coordinated monetary policy is morphing into globally competitive monetary policy. This may be the most significant Macro development since the Plaza Accord in 1985 when the Reagan administration, along with other developed nations (West Germany, France, Japan, the UK), coordinated to weaken the U.S. dollar.
With the Presidential
election in about 15 months, we have no doubt that President Trump will do
everything in his power to keep financial markets and the economy humming along.
The problem facing the President is a Democrat-controlled House, a Fed that is dragging
their feet in terms of rate cuts, weakening global growth, and a stronger U.S. dollar.
the odds that the President tries to weaken the dollar will rise quickly if
signs of further economic weakness emerge. Given the situation, investors need
to understand what the President can and cannot do to spike economic growth and
further how it might affect the prices of financial assets.
equity front, a weaker dollar bodes well for companies that are more global in
nature. Most of the companies that have driven the equity indices higher are
indeed multi-national. Conversely, it harms domestic companies that rely on
imported goods and commodities to manufacture their products. The price of
commodities and precious metals are likely to rise with a weaker dollar. A
weaker dollar and any price pressures that result would likely push bond yields
relationships between the dollar and various asset classes are important to
monitoring how intentional changes in the value of the dollar may impact all
varieties of asset classes. The addendum below quantifies short and longer-term
Addendum – Short & Long-term Asset Correlations
following tables present short term daily correlations and longer-term weekly
correlations between the dollar and several asset classes and sub-asset classes.
The correlation data for each asset quantifies how much the price of the asset
is affected by the price of the dollar. A positive correlation means the dollar
and the asset tend to move in similar directions. Conversely, a negative
relationship means they move in opposite directions. We highlighted all relationships
that are +/- .30. The closer the number is to 1 or -1, the stronger the relationship.