Investors and policymakers continue to wrestle with the economic impact
of the dollar's rise. The Federal Reserve has argued that the
dollar's appreciation acts as a headwind
on exports and dampens imported inflation. At the same time, despite the
dollar's appreciation and the fall in oil prices, core inflation rose steadily
last year.
Core CPI rose from 1.6% at the end of 2014 to 2.1% at the end of
2015. The core PCE deflator lagged, but the after bottoming last July
below 1.26%, it finished the year near 1.41%.
Fed officials have a nuanced understanding of the dollar. On
one hand, the share of exports in the US economy are less than half of
Germany's for example, and much of what the US imports is invoiced in dollars, the greenback's exchange rate is not often
a particularly important variable in the policy-making
equation.
However, when there is a sharp dollar move, it becomes more salient.
Since mid-2014, the nominal trade-weighted dollar index that the Federal
Reserve tracks by nearly a quarter through the end of last month. Adjusted for inflation, the dollar's
appreciation was a little less than 20%.
On the other hand, Fed officials argue that impact of the dollar's rise
is transitory. By that, officials direct investors' attention to the
rate of change. The economic is largely
driven by the pace of change, not the level. The level may not
be transitory, but the rate of change is unlikely to be sustained.
That means the impact on prices and exports will moderate in time.
For example, in the nine-month stretch from mid-2014 through Q1 2015, the
nominal trade-weighted dollar appreciated by 19%. The impact
may still linger then in Q1 16, but then it should fade. Since last March, the dollar has risen almost 5.5%,
which is not nearly as riveting.
Part of the challenge
for investors is that the Federal Reserve's trade-weighted measures of the
dollar are updated monthly.
However, there is a real-time measure
that is nearly as good. It is the Bank of England's measure of a nominal
trade-weighted dollar index.
The Great
Graphic here shows how closely the BOE's measure tracks the Federal
Reserve's nominal trade-weighted dollar index. The Fed's
measure is the white line. The BOE's measure is the yellow
line. Now that the tight fit has been established, we can see what the BOE's
measure has done since the start of the month. That is what this second
chart shows.
The BOE's nominal trade-weighted dollar index has fallen 3% since the end
of January. This brings
the index back to levels since in early
November, before the run-up that was seen ahead of the anticipated Fed hike in
December and the anticipated easing by the ECB.
Despite the heaviness of oil prices, the Canadian dollar is slightly
firmer now compared at the end of
January. However, the currencies of the other two main trading
partners have seen their currencies rise more significantly. The yen has
gained 5.8% since the end of January, and
the euro has risen 4.25%.
Of course, the March FOMC meeting is still more than a month away.
However, it appears that the movement of the decline of the trade-weighted
dollar may reduce its salience in the Fed's decision-making.
The dollar's appreciation was also an input into financial condition models
that point to a tightening of conditions. The dollar's contribution to
this is less so now.
Disclaimer
Great Graphic: Dollar May Be Less Important for Fed
Reviewed by Marc Chandler
on
February 09, 2016
Rating:
Reviewed by Marc Chandler
on
February 09, 2016
Rating:
