Donald Trump won’t like it, but the Fed is keeping the US dollar strong with its rate cut
- The US Federal Reserve is cutting interest rates not for domestic reasons but in response to slowing global growth and Trump-induced trade anxiety. Effectively, it is creating space for other central banks to ease rates too
In a statement, the Fed said its decision on a second rate cut this year was driven by “the implications of global developments for the economic outlook as well as muted inflation pressures”.
In fact, at the press conference after the Fed’s meeting, Fed chair Jerome Powell pointedly said that the baseline scenario for the US economy remains “favourable” but that “since the middle of last year, the global growth outlook has weakened, notably in Europe and China”.
Since the Fed’s last meeting in July, it has “seen additional signs of weakness abroad and a resurgence of trade policy tensions, including the imposition of additional tariffs,” Powell said. In his view, “trade policy developments have been a big mover of markets and of sentiment during that inter-meeting period”.
From a currency perspective, such an explanation for the Fed’s rate cut might well lead investors to continue to prefer the US dollar to other currencies.
Additionally, even with last week’s rate cut, the yield on offer in the US is more attractive than that elsewhere. “The USD remains the ‘high yield’ play in (the Group of 10 forex) and will likely continue to capitalise on its yield advantage,” HSBC Global Research noted.
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Although the Fed said in its statement, “On a 12-month basis, overall inflation and inflation for items other than food and energy are running below 2 per cent”, markets are unlikely to ignore the data released on September 12 that shows the US core consumer price index increased 2.4 per cent year-on-year in August, the most since July 2018.
This uptick in the US’ core consumer price index is occurring even though broad US dollar strength continues to shield the US economy from too much imported inflation.
Meanwhile, over in the euro zone, not only has the European Central Bank gone further into negative interest rate territory, it will also engage in an open-ended programme of asset purchases that is intended to further suppress borrowing costs in the currency bloc.
In comparison, even after the Fed’s latest rate cut, US yields look generous.
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Elsewhere, with the South Korean economy flagging somewhat, the Bank of Korea may well decide to trim interest rates again next month, having previously cut to 1.5 per cent in July.
Australia may also act next month. Over in Tokyo, the Bank of Japan left ultra-accommodative policy settings unchanged last Thursday but it could well choose to ease policy even further next month.
BOJ governor Haruhiko Kuroda said at a press conference after the policy announcement: “We are more eager to act given heightening global risks. We will scrutinise economic and price developments thoroughly at next month’s meeting to decide whether to ease.”
Policymakers in Jakarta didn’t hesitate. Bank Indonesia followed the Fed last Thursday and cut rates.
At a time when the global economic outlook has weakened while the US economy, at least for now, appears to be in reasonable health, the Fed’s precautionary rate cut has just created space for other central banks, especially in Asia, to ease their own monetary policies. On currency markets, this might mean the US dollar ends up winning almost by default.
Neal Kimberley is a commentator on macroeconomics and financial markets.