FYI | Mar 18 2008
By Greg Peel
US Treasury secretary Henry Paulson emerged from last night’s meeting of the President’s Working Group on Financial markets and said, “We have a strong dollar policy and it’s very much in the nation’s interest,” as if someone had pulled the string in his back yet again. But Paulson would not be drawn on whether the US Treasury had any plans to intervene in the currency markets to halt the US dollar’s further accelerated decline.
The dollar has fallen this year by 8% against the euro, to US$1.5729 last night, and by 12% against the yen, falling to 97.23 yen.
The Fed is tonight expected to cut the US cash rate by at least 75 basis points and perhaps 100. That would take the rate to either 2.25% or 2%. Analysts now expect the Fed will ultimately keep going to 1%. With the ECB holding steady at 4% – struck rigid by inflation fears (which a falling dollar exacerbates), and the BoJ unable to shift from 0.5%, the ever-widening interest gap can only seal the US dollar’s fate. The Fed needs to cut the rate to square the other side of the equation, which has seen an extraordinary increase in liquidity injection, a shift to include investment banks as well as commercial banks as candidates for collateral swaps, an increase in the scope and duration of those swaps, and a further 25 basis point cut in the discount rate – the rate at which such funds can be accessed.
While the Fed is fully aware of the effect its actions have on the US dollar, both the dollar and inflation have had to take a backseat to the clear and present danger of a financial markets collapse.
The fall in the US dollar has pushed up the price of all commodities, but on the flipside it has made US exports more attractive. On both counts this is a kick in the stomach for the second and third largest economies in the world. Industry in Japan and Germany is suffering earnings erosion and loss of business as the price of exports grow ever higher. It is in the interest of both Europe and Japan to help prevent the US dollar’s slide. As this is not about to happen naturally under a free market regime, the time is approaching for the treasuries of the G7 to intervene and save the dollar. This would mean the US government opening up its own coffers (rather than that of the Fed) and buying the greenback, in a coordinated effort of selling of the euro and yen in a general cooperation of all of the G7.
As the US dollar has slid given general risk fears, the currencies of emerging market economies have also begun to tumble. Countries such as Turkey, Hungary, Romania and South Africa have seen their currencies caving under pressure. Carry trade currencies such as the Aussie and Kiwi dollars and the pound are also beginning to buckle as the world unwinds the carry trade by buying yen and selling positions elsewhere. China, whose currency is pegged to the US dollar, has had to raise interest rates to try to push the value of the renminbi higher.
A hint on possible intervention in the US dollar was dropped by Japanese finance minister Fukushiro Nukaga yesterday. “We will cooperate with European and US currency authorities and will monitor markets very carefully,” Nukaga told reporters, adding that currency fluctuations had been excessively volatile. Reuters reports one Japanese forex manager as noting that these comments were a shift away from the usual finance ministry rhetoric, thus elevating the chance of intervention.
The problem is, however, that any effort to save the dollar will need to be translated into interest rate cuts elsewhere, particularly in Europe. As to whether the ECB is prepared to abandon its inflation-concern stance is in doubt. Even if the ECB were to remain unchanged, this would at least be a change from what traders have been expecting, being an inevitable ECB interest rate hike as inflation soars.
The next problem is that even if the G7 does intervene, it may not work.
“I can’t think of a time when the US was simultaneously easing monetary policy and intervening in the currency markets,” Jeffrey Frankel, a professor at the Kennedy School of Government at Harvard University, told the Wall Street Journal. The confluence of those two government actions, he added, would risk cancelling each other. That could leave the dollar vulnerable to further declines.
And other comments suggest a move to save the US dollar could only be a temporary fix would which provide the opportunity for traders to line up and sell the currency once more.
In the meantime, the Bank of England is wrestling with its own problems.
The FTSE plunged nearly 4% last night – it’s close coinciding with the bottom on Wall Street. While Wall Street did rally later in the session, the pain in the UK was felt in the financial sector. The UK has so far proven to be the biggest collateral damage victim of the US financial meltdown, and is now itself facing a possible housing crisis. Shares in HBOS, Barclays and the Bank of Scotland lost 9-12%.
The BoE immediately countered by offering a further 5 billion pounds of liquidity, but when the “window” was opened there were collective requests for a total of 23.5 billion pounds, The Times reports. One broker argued that the BoE “has to stop worrying about the price of bread and start worrying about the banking system,” in reference to the Bank having made only one interest rate cut – 25 basis points to 5.25% – since the credit crisis began. That cut was made in July as an immediate response to what was the initial Bear Stearns disaster. Despite the crisis having worsened exponentially, and with Bear Stearns now gone, the BoE has cited inflation as the excuse for not having cut rates any further.
British brokers’ views are no doubt being echoed in Berlin and Tokyo.
Meanwhile in Australia, the RBA is continuing its inflation watch as well. In its last statement it did acknowledge that interest rate rises to date, combined with independent rate increases for banks, may be enough at present to suggest a halt. But the latest employment data suggest a wage inflation spiral is still a very real possibility. In the meantime the Australian banking sector has lost over 30% of its value, and elevated mortgage and consumer debt levels are posing concerns of a household debt meltdown.
The question is at what point would the RBA also contemplate a rate reduction?
