The cycle of monetary tightening has been ongoing in various forms for over five years. First came Bernanke’s taper warning in May 2013. Next came the actual taper in December 2013 that ran until November 2014. Then came the removal of forward guidance in March 2015, the liftoff in rates in December 2015, four more rate hikes (so far) in 2016 through 2018, and the start of quantitative tightening in October 2017.
Another rate hike is already in the queue for June 2018. During much of this tightening, the dollar was actually lower because markets believed the Fed would not raise in the first place, or was overdoing it and would have to reverse course. Now that the Fed has shown it’s serious and will continue its tightening path (at least until they cause a recession), markets finally believe them.
This changed perception has caused a dollar rally as investors look at interest rate differentials between the U.S., on the one hand, and other rate markets such as Germany and Japan on the other. Yet, as this article describes, a stronger dollar is itself a form of monetary tightening.
A stronger dollar cheapens imports for U.S. buyers because they need fewer dollars to purchase goods. That’s a deflationary vector that will make the Fed’s goal of achieving inflation even harder to reach. The U.S. is now getting a triple shot of tightening in the form of higher rates, reduced money supply, and a stronger dollar. At this rate, we may be in a recession before the end of 2018 unless the Fed reverses course, which they may well do by this September or December.
Meanwhile market distress is emerging from Argentina to Turkey. We’ll see if the Fed wakes up to the danger before it’s too late.
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