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US President Donald Trump has called for a weaker dollar. Is the Federal Reserve cutting interest rates to give him what he wants? Photo: AFP
Opinion
The View
by Moritz Kraemer
The View
by Moritz Kraemer

The Federal Reserve should not be helping the US become a closet currency manipulator

  • The US central bank does not have a strong case for a rate cut and a looser policy. With a widely expected rate cut imminent, the Fed chief might be bowing to pressure from Donald Trump to weaken the dollar
Moritz Kraemer
Moritz Kraemer
Why you can trust SCMP
The futures market has assigned a 100 per cent probability to a Fed rate cut of at least 25 basis points on July 31, which would be the first such move in over a decade. In late May, the expected likelihood had been less than a fifth.

But in congressional testimony in mid-July, Federal Reserve chair Jerome Powell was understood to have all but promised a cut in interest rates sooner than later, possibly followed by more. A dove was born.

On the face of it, there is little to justify a policy reversal. The United States central bank has a dual mandate: maximising employment and stabilising prices. It is doing well on both fronts.

In April unemployment hit a 49-year low. The economy added 224,000 jobs in June, and wage increases remain strong. A labour market so tight cannot be reasonably construed as a basis for a looser monetary stance in order to maximise employment.
A looser monetary policy cannot offset policy uncertainty in any lasting way. On the contrary, a rate cut will give the haphazard policymakers more rope, leading to bigger perils down the road

What about stabilising prices?

At 1.6 per cent, inflation in June was the feeblest in four months. Even so, such a level hardly signals deflationary threats. Average monthly inflation so far this year stands at 1.7 per cent, close enough to the inflation target of 2 per cent.

More importantly, inflation expectations remain anchored: the five-year, five-year forward inflation expectation rate has been oscillating around the target lately and currently stands at 2 per cent, bang on target.

The kind of stuff that Mario Draghi’s and Haruhiko Kuroda’s dreams are made of.

So why has Powell reversed course? He argues that it is insurance against global risks like trade disputes and Brexit. This is unconvincing.
US Fed chair Jerome Powell attends a Federal Reserve Board meeting on April 8. The Fed has a mandate to stabilise prices and as things stand, there is no cause to worry about deflationary pressures. Photo: Bloomberg
The risk from Brexit did not change materially in recent months, while the truce agreed to by presidents Donald Trump and Xi Jinping at the G20 Summit in Osaka mitigated trade risks at least for the time being.

Even assuming the trade war escalates, the loss in US economic output would be a mere 0.13 per cent, according to estimates by the Peterson Institute for International Economics.

Is the Fed cutting rates to save the US economy from Trump?

It is unreasonable to conclude that in such a scenario, meaningful deflationary pressures would set in. Instead, more US tariffs would lift inflation to the Fed’s numerical target.

The main downside risk to the US economy is the Trump administration’s slapdash way of introducing policies.

According to policyuncertainty.com, US economic policies are now as unpredictable as they have been this millennium. This capriciousness has weighed on business confidence.

But a looser monetary policy cannot offset policy uncertainty in any lasting way. On the contrary, a rate cut will give the haphazard policymakers more rope. This will lead to bigger perils down the road.

The economic case for loosening policy is thus weak. It looks more likely that Powell has been caught in a pincer movement, between Trump’s chest-thumping threats and Wall Street’s rate-rise anxiety disorder.
Trump’s mercantilist world view calls for the reduction of the US trade deficit. For that he slaps tariffs on friends and foes alike.
He also calls for a weaker dollar. The greenback had risen in tandem with interest rates as carry-trading investors shifted portfolios into dollars. By cutting interest rates, the Fed could hand a weaker dollar to Trump on a silver platter.

Alas, if the US is trying to be a currency manipulator it won’t work. Other central banks have turned more dovish too, thwarting desired dollar depreciation. The trade-weighted dollar has lost only a sixth of its strength since the beginning of 2018.

What Donald Trump got wrong about China’s economic decline

Powell has missed the opportunity to pull the Fed out of Trump’s futile attempt to wage a beggar-thy-neighbour currency war.

On July 31, Powell is expected to announce the Board of Governors’ decision to cut rates. It will be another step towards putting the central bank’s independence from financial markets and political interests in doubt.

Moritz Kraemer is the chief economic adviser of Acreditus, a Dubai-based financial advisory firm, and a former chief global ratings officer for sovereigns at S&P Global

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