Europe Economy

Could the Federal Reserve Undo the Dollar’s Rally?


The U.S. dollar has risen to five-week highs against the yen and euro, but central bank policy actions (or the lack thereof) in Europe, the U.S. and Asia could unravel the recent rally in the currency, analysts told CNBC.

United States Federal Reserve
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The dollar has been boosted by better U.S. economic data such as retail sales, jobs and consumer spending for July and investors too have been showing the color of their money by “piling in” to sales of short-term U.S. Treasuries, pushing yields to near-zero or negative (link) 

Indeed, as the euro and yen wax and wane on hopes of more quantitative easing by the and the Bank of Japan, the dollar has been steadily climbing since September 2011, and is up five percent against a basket of currencies since May this year.

The dollar is finally “being traded on the outlook for the U.S. economy rather than on risk appetite,” according to Kathy Lien, Managing Director of FX Strategy for BK Asset Management, while other strategists say the meeting of central bank officials in Jackson Hole, Wyoming on August 31st will be key for the future direction of the currency.

Markets are waiting to see if Bernanke will provide any further clues at that meeting on whether further stimulus in the form of quantitative easing (QE) is warranted for the economy.

Simon Derrick, Chief Currency Strategist at BNY Mellon and a self-confessed “mild dollar bull”, told CNBC that he didn’t think more QE was likely and hence the dollar would remain strong.

“If you look at the dollar’s performance over the last few years when quantitative easing has been introduced, the dollar was absolutely weaker…were they to reintroduce QE would that reintroduce dollar weakness?  Absolutely.”

However, he added that the fiscal cliff of higher taxes and lower spending looming at the end of 2012 could damage the dollar’s momentum.

“I do think that the lack of a third round of QE is a dollar positive but the fiscal cliff debate is going to take some of the heat out of it,” he said.

Derrick’s view was countered by analyst Neil Dwane, Chief Investment Officer for Europe at Allianz Global Investors who told CNBC that there was still an expectation of central bank action but the forthcoming U.S. elections could prevent action.

“I would argue that there’s an expectation all around the world…that Ben Bernanke has to do something sooner rather than later as he can’t interfere in the [economy] in the run up to U.S. elections unless something major happens,” he said.

Indeed, rather than central bank inertia being to blame for currency instability, Dwane told CNBC that it was the political sphere that needed to intervene to improve the global economy as a whole.

“I think the fundamentals remain clear.  Austerity and money printing isn’t going to change the structural efficiencies, or inefficiencies, in an economy.  That’s hard graft (work)and politics [that must do this] as so far, no economy in the world is showing a clear intent to change things.”