Dollar strength reflects global policy divergence, not direct intervention.
What goes around comes around.
In September 2010, Guido Mantega, then Brazil’s finance minister, popularised the term “currency wars.” He claimed governments around the world ”’ led by the U.S. ”’ were engaging in competitive devaluations of their currencies. Brazil and other emerging markets, which were doing better at the time, suffered overvalued currencies as a result.
Fast forward to today and the U.S. dollar has appreciated on a trade-weighted basis at a faster pace for the past eight months than during any similar period since the end of the Bretton Woods system in 1971. This year, more than 20 central banks have eased monetary policy, including the European Central Bank, which at long last launched its quantitative easing programme. Meanwhile, at the U.S. Federal Reserve’s press conference last month, Fed Chair Janet Yellen acknowledged that the U.S. dollar’s strength was part of the reason for downward revisions in the Fed’s growth and inflation forecasts.
Is the Fed the casualty in a currency war? In truth, while a catchy phrase, it is not an altogether helpful one. The U.S. dollar’s strength reflects fundamental economic and policy divergence versus the rest of the world, not direct exchange rate interventions. The euro’s weakness, of course, reflects the ECB’s QE, but this policy loosening is not an act of trade war: it is a reaction to the very real risk of entrenched deflation that the eurozone faces.
The U.S. dollar aside, the main message from the Fed in March was that interest rate increases will be on the table, not in April, but at its June, September or December meetings. This cyclical divergence in policy is not surprising. The U.S. is far more advanced in terms of its post 2008 crisis rehabilitation compared with other developed countries and is a primary beneficiary of the decline in energy prices compared with the overall net negative impact on emerging markets.
