The US Federal Reserve’s monetary course risks leaving the dollar to sink
- As pent-up consumer demand for imports drives up the US trade deficit amid rising inflation, the Fed’s unchanged policy could seriously hurt the dollar
“Steady as she goes” may be a nautical phrase but it neatly sums up monetary policy settings in the United States after last week’s Federal Open Market Committee meeting. But, to extend the maritime theme, the Federal Reserve’s stance may leave the dollar listing badly.
The Fed may see inflationary pressures as transitory but investors will have noticed the eye-catching increase in the US gross domestic product deflator in data released last Thursday.
The deflator – a measure of changes in the prices of US goods and services, including exports but not changes in the prices of US imports – rose by 4.1 per cent in the first quarter of this year compared to the previous three months.
As long as overseas buyers of US government bonds continue to buy into the Fed’s interpretation of US inflationary pressures as transitory, their purchases of US government paper indirectly help to support the dollar’s value in the currency markets.
But if they start to reject the Fed narrative and buy fewer US government bonds, or even start selling their holdings in the belief that US inflationary pressure justifies higher Treasury yields and lower Treasury prices, then a pillar of currency market support for the dollar is eroded.