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The Federal Reserve announced the results of its much-anticipated meeting yesterday.
Long story short, it did what the market wanted. It didn’t lower interest rates, but indicated that it expects it will have to at least twice this year.
Overall, it kept the market happy. It kept investors believing that the central bank “put” is firmly in place.
But the pressure is still on Fed boss Jerome Powell. Donald Trump is turning up the heat – by directing his complaints away from the US central bank and onto others.
Currency wars now mean war
In 2010, Brazil’s finance minister, Guido Mantega, talked about currency wars, referring to the rounds of quantitative easing (QE) taking place around the world. The idea was that looser monetary policy was, in effect, a “beggar thy neighbour” approach.
Your currency gets weaker, so your products get cheaper relative to those of other countries, and so you benefit at the expense of other nations around the world. It was viewed as a modern-day version of tariffs – a repeat of the protectionist spiral we saw after the Great Depression.
However, by and large, the currency “wars” didn’t really get nasty. In reality, it ended up being more like a game of “pass the hot potato”. There was a sense of coordination and cooperation among the world’s central banks.
A good example is when Japan pretty much explicitly made a weaker yen part of its economic recovery plan just after Shinzo Abe was elected in 2012.
On the one hand, it’s not really the done thing. On the other hand, Japan did have an extraordinarily strong currency at the time, and it was also viewed as a good thing to have the world’s third-largest economy actually contributing to global growth if possible. So everyone let it slide.
Or take the eurozone crisis. Everybody knew that European Central Bank (ECB) boss Mario Draghi had only one policy lever open to him that the Germans couldn’t block out of hand. That was to talk the euro down aggressively, offering a morsel of relief to the likes of Italy and Greece until he had managed to win the “hard euro” contingent round.
In short, there was an implicit tolerance of the policy. Everyone agreed to pretend that it wasn’t happening, and in return, no single country took the mickey too badly.
As you may have noticed however, we’re no longer in the mood for co-operation and co-ordination. And the mood from the US is that any act by a foreign power to make itself more competitive is an act of trade aggression against the US.
Whatever else you want to say about Donald Trump, he understands that a weaker US dollar is good for the stockmarket, and a stronger one is bad for it. He also understands that a rising stockmarket is good for his electoral chances.
That’s why he went off on one on Twitter earlier this week when Draghi made it very clear at an ECB shindig in Portugal that, in effect, he’s ready to keep doing “whatever it takes” right up until his retirement date later this year. That sent markets higher.
However, Trump’s response on Twitter was this: “Mario Draghi just announced more stimulus could come, which immediately dropped the euro against the dollar, making it unfairly easy for them to compete against the USA. They have been getting away with this for years, along with China and others.”
So there you go. No more “nudge and a wink” – currency wars mean war.
I suspect Powell will give Trump what he wants
This is going to make things interesting. Trump has been nagging Fed chairman Jerome Powell to cut interest rates for a while. He’s been talking about having a weaker dollar for a long time.
He now seems to have decided that if Powell won’t give him what he wants, then maybe threatening the other competitors in the race to the bottom will work instead.
Arguably the path of least resistance here is for Powell to accept that weakening the US dollar is now his priority. Otherwise, Trump will go ahead and start talking about imposing tariffs on the likes of Germany and the rest.
And despite Draghi’s best efforts, I do wonder how much more he can do. Who will take over from him later this year? Will they be as good at bluffing and playing a tricky hand as Draghi has been? Particularly as the political backdrop they are inheriting is even tougher than the one he was working with?
When in doubt, I like to ask: “What is the biggest sucker punch the market could throw in the faces of investors right now?” There isn’t always an obvious answer to that question, because the market is not always positioned at an extreme. There isn’t always an obvious contrarian trade at the “big picture” level of the market.
However, right now, there is no doubt in my mind about the answer to that question. The one thing that would really is: “higher-than-expected inflation”.
The first step towards that is a much weaker dollar. Until the dollar turns that corner, I can see why the market is still investing so heavily in the deflation scare. But when the psychology turns, it’s going to hurt a lot of investors.
We’ll be tackling this topic along with many others at the MoneyWeek Wealth Summit in November this year. If you haven’t already signed up to be the first to know when the tickets go on sale, get your name down here.