The USD has come off recent highs, apparently in response to President Trump complaining about Fed rate hikes and accusing other countries of manipulating their currencies. This raises the question of whether there is much that he can do to affect Fed policy or to drive the exchange rate lower. We are dubious.
Markets had a taste of this in late January when Treasury Secretary Mnuchin was seen to be trying to talk the currency lower, noting the weaker dollar was good for trade. USD showed brief concern, but it has strengthened about 7% since then, with no policies to back up Mnuchin’s comments.
Similarly, Trump might prefer low interest rates, but he has no practical means of affecting policy decisions, either directly or via appointments to the Fed board. An obviously political nomination would have little chance of securing Congressional approval – even credible candidates often struggle.
In fact, Trump’s nominations have been uncontroversial and show no attempt to politicise the Fed. The root of his criticism might simply be an insurance policy – he is looking for somebody to blame if growth fades before the next presidential election.
Another Fed rate hike at the late-September FOMC looks like a done deal and the minutes from the latest meeting give no hint of a break from the recent path of a hike each quarter. The analytical and decision-making structures of the Fed should be resistant to political influence.
The policy outlook for next year contains the usual uncertainties. Note that the Fed is shifting to holding a press conference after every meeting, which is seen as making each one “live” and so easier to shift from the once-per quarter pace. Rising inflation could lead to pressure for a faster pace of tightening, or growth disappointments could lead to a pause, but for the moment the Fed seems comfortable with the current path.
In terms of currency manipulation, developed economies are not intervening directly and can hide behind the defence that any exchange rate weakness is just a consequence of monetary policy. Even China can argue that CNH weakness would be more pronounced if it were not intervening to tighten controls on capital outflows, so any manipulation is producing a stronger, not weaker, currency.
Import tariffs should theoretically send an exchange rate higher, so perhaps Trump himself is the main currency manipulator. Of course the US could intervene directly in currency markets by using its Exchange Stabilisation Fund to sell USD, but history shows that such unilateral action tends to be ineffective.
Talk is cheap, but its impact is limited. We suspect that we are approaching peak policy divergence, which will be one of the limitations to stronger USD.
Trump’s legal and political troubles might make for entertaining television, but they seem unlikely to have a significant impact on policy. Tax reform is done and the president has the authority to drive trade policy, while there are no other big items on the economic agenda. At some point Congress will need to act (and cooperate with Trump) if it wants to prevent a material fiscal tightening in 2020 as the recent boost fades, but it seems too early to try to assess the related political dynamics.
In conclusion, we think that the Fed and the USD will respond to economic fundamentals and not to political jawboning. This points to more Fed rate hikes, but also eventually a softer USD as it is weighed down by the twin deficits and as more developed economies join the policy tightening cycle.Disclaimer applicable to recommendation
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