November 9, 2007
Bernanke’s larger than expected 50 bps cut on September 18 helped spark a sell off in the U.S. dollar. A deteriorating outlook for the U.S. economy and another Fed rate cut on October 31 accelerated the dollar’s decline. Fear has taken over in November…
It is not surprising that against this backdrop talk about how wonderful a weaker dollar is for America has nearly vanished. As a quick example, head of currency research at Morgan Stanley, Stephen Jen, was claiming a few weeks ago that although the dollar may weaken further, “…investors should keep in mind that the dollar is undervalued and ready to appreciate as soon as the economy regains traction.” The most recent sell off in the dollar now has Mr. Jen rattled, not to mention many others:
“This is the first time in my career that I am really worried about the dollar I didn’t know it was going to go so far. The dollar is in trouble. What has so far been an orderly move can easily degenerate into a more violent event.” Little hope on horizon for troubled dollar
Whether or not a U.S. dollar crisis is imminent is, of course, impossible to say. Sometimes volatility can presage more volatility while other times it simply marks tops and bottoms. However, what can be assured is that regardless of any bounce in the dollar (perhaps coinciding with next weeks G20?), the longer-term outlook for the greenback remains negative.
Not surprisingly, Fed Chairman Bernanke offered few assurances on the dollar yesterday as he did a fish out water routine in front of the Joint Economic Committee:
"We're going to make sure that the inflationary impact that may come from the weakening dollar is not passed into broader prices" Reuters
Beyond keeping the inflationary statistics rigged, how exactly can Bernanke accomplish such a feat? Well, he could go so far as to raise interest rates to try and save the dollar, or he could raise bank reserve requirements to help slow credit growth and/or he could tightly monitor the Fed’s windows (i.e. slow the money supply). But what Bernanke definitely can not do to save the dollar is bailout Wall Street, save the U.S. economy from recession, and keep the U.S. equity markets rolling along at the same time.
Does Bernanke Have The Right Stuff?
Bernanke’s Fed is only two fed fund rate cuts into what could be a prolonged easing campaign and the dollar is already collapsing. This is deeply unnerving in that it suggests the Greenspan doctrine of cutting interest rates first and asking questions never is broken. Having little to show for his meetings, phone calls, and rate cuts relating to the subprime mess, will Bernanke really be able to amass a coalition of the willing to support the U.S. dollar when the time comes? Secretly or openly negotiating an FX intervention plan with other central banks isn’t exactly something Bernanke would have learned to do in Academic circles.
In recent weeks the markets have speculated that the Saudis may drop their peg, that other Gulf states and sovereign wealth funds in the area are lightening their exposure to the dollar, and that OPEC continues to eye settling in Euros instead of dollars. Also recently China and Japan dumped a combined $33 billion is U.S. Treasuries (in August), and Chinese officials have continued to discuss reducing exposure to the dollar. Suffice to say, that against an already uncertain backdrop U.S. dollar holders are coming forward threatening to fan the flames and talk of the dollar era being over is running hot is hardly encouraging. Less encouraging still is the fact that those who previously cheered the dollar’s decline are turning scared.
“The dollar will trade at $1.51 per euro by year-end, compared with a previous forecast of $1.42, and it will fall to $2.13 per pound and 108 yen, compared with previous forecasts of $2.03 and 112.” Jen. Bloomberg
In short, while a weakening U.S. dollar was supposed to bring about a much needed global ‘rebalancing’, dollar weakness has instead coincided with a global economy ‘de-coupling’. This situation threatens to idle Bernanke’s helicopter, quicken the pace of confidence erosion in the U.S. dollar, and, potentially, turn a ‘much needed’ dollar devaluation into a historic conflagration. With his bailout checklist quite full, Bernanke can temporarily be forgiven for not running to the dollar’s rescue. But with Wall Street prodding the Fed for another rate cut in December and international confidence in the dollar potentially near a snapping-point, Bernanke may need to quickly consider breaking further from the Greenspan script and adopting a firm and transparent policy stance to support the U.S. dollar. More focused on the art of combating deflation than anything else, no wonder Bernanke is squirming…