Tags: dollar | Federal Reserve | economy | policy

Why This Dollar Surge Is Different for Federal Reserve

Why This Dollar Surge Is Different for Federal Reserve

 (Dreamstime)

Thursday, 27 October 2016 09:22 AM EDT

The dollar has returned to highs it last reached nine months ago. The drivers of this increase are similar to those that caused the currency to surge earlier this year. Yet, this time, the impact on financial markets has been quite different. And if this persists, the implications for Federal Reserve policy will also be different.

Traders have pushed the dollar higher based on their confidence of an approaching divergence in central bank policies – that is, a tightening by the Fed even as other systemically important institutions such as the European Central Bank, the Bank of Japan, the Bank of England and the People’s Bank of China maintain or intensify their loose stance. But in contrast to the earlier period, the impact on U.S. stocks has been very muted.

Instead of enduring a selloff in response to currency-induced competitive pressures -- which is what happened in the first quarter -- U.S. stocks have been well-behaved. A heavy deal calendar has helped as investors cheered the influx of merger-and-acquisition funding into the marketplace, whether from corporate cash held on balance sheets or new debt financing. As a result, financial conditions have remained highly accommodative, despite the appreciation of the dollar.

Equity investors have also been reassured by the growing -- and correct -- recognition that this Fed hiking cycle will depart drastically from historical norms. Instead of following a relatively linear path of increases at regular intervals, it will have pronounced “stop-go” characteristics. Also, and perhaps more importantly, the endpoint -- or what economists call the “neutral rate” -- will be considerably lower than recent historical averages.

An open question is whether the Fed will be able to pull off this gradual and measured tightening of financial conditions without upsetting markets that have become used to exceptional support from central banks. What is clear, however, is that the recent strengthening of the dollar, of itself, is unlikely to be a deterrent to a rate hike for the rest of this year. That is most likely in December rather than at the Federal Open Market Committee meeting next week.

Sensing this, markets have already raised the implied probability of Fed action in December to almost 75 percent. Together with relative short-term economic and financial calm abroad, including a lot less worry about a hard landing in China, this will comfort the Fed, which is already inclined to take a further step, albeit a small one, to normalize monetary policy. Moreover, when viewed in relative terms, this normalization of monetary policy in the context of a stronger dollar contributes to the “global rebalancing” needed to put the world economy on a firmer footing.

But ultimately it will be absolute fundamentals, rather than relative trends, that secure a prosperous global economy and genuine financial stability. And a sufficiently robust foundation still eludes us.

The upcoming rebalancing will be attempted in the context of growth rates that remain too low and are insufficiently inclusive, which increases the risk of further political polarization, dysfunction and an economic derailment. Until the basic challenge of generating high and inclusive growth is overcome, the Fed’s normalization process will be far from automatic and the risk of market instability will remain too high to ignore.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed El-Erian is the chief economic adviser at Allianz SE.

© Copyright 2024 Bloomberg News. All rights reserved.


MohamedElErian
The dollar has returned to highs it last reached nine months ago. The drivers of this increase are similar to those that caused the currency to surge earlier this year. Yet, this time, the impact on financial markets has been quite different.
dollar, Federal Reserve, economy, policy
564
2016-22-27
Thursday, 27 October 2016 09:22 AM
Newsmax Media, Inc.

Sign up for Newsmax’s Daily Newsletter

Receive breaking news and original analysis - sent right to your inbox.

(Optional for Local News)
Privacy: We never share your email address.
Join the Newsmax Community
Read and Post Comments
Please review Community Guidelines before posting a comment.
 
Get Newsmax Text Alerts
TOP

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

NEWSMAX.COM
MONEYNEWS.COM
© Newsmax Media, Inc.
All Rights Reserved
NEWSMAX.COM
MONEYNEWS.COM
© Newsmax Media, Inc.
All Rights Reserved