The Dollar, the Fed and Foreign Inflows: Understanding How These Key Fundamentals Affect Dollar-Based Exchange Rates Can Prime You for Potential Trades and Keep You Flat When Shocks Could Move the Market against You

By Laidi, Ashraf | Modern Trader, September 15, 2004 | Go to article overview

The Dollar, the Fed and Foreign Inflows: Understanding How These Key Fundamentals Affect Dollar-Based Exchange Rates Can Prime You for Potential Trades and Keep You Flat When Shocks Could Move the Market against You


Laidi, Ashraf, Modern Trader


As we head into the last three months of the year, currency traders remain at pains in predicting the course of the U.S. dollar to year's end. With the uncertainty of U.S. elections adding to the lack of visibility regarding the sustainability of the U.S. economic recovery, and with the extent of monetary policy shifts in and outside the United States doubtful, there is a range of market scenarios, each of which commands considerable probability.

But the two issues surrounding the dollar, which are increasingly making the rounds in forex trading desks, are those of the Fed and foreign capital flows into the United States. While few doubt the direction of U.S. interest rates, there remains as much dissent over the extent of Fed tightening as on its impact on the dollar. We will explain the impact of past Fed rate hikes on the dollar in the hope of shedding light about the forex effect of the current tightening cycle. As for capital flows, the increased role of U.S. Treasuries as the major recipient of foreign capital is raising questions about the over-dependence on foreign creditors. It is these very creditors that shall stabilize the dollar from any renewed damage.

"Spurious relationship" (right) is a clear illustration of the lack of a direct relation between the U.S. dollar and interest rate tightening policies over the last three decades. Indeed, higher yields improve the appeal of U.S. fixed income securities for investors seeking the extra yield. As investors rush in U.S. securities, they drive up the value of the U.S. dollar. But as the chart shows, the tightening cycles of 1976-79 and 1994-95 failed to generate any dollar gains.

[ILLUSTRATION OMITTED]

Between fall 1977 and fall 1978, the dollar fell more than 15% after U.S. Treasury Secretary Michael Blumenthal talked down the U.S. currency in the hope of pressuring Germany and Japan to stimulate their economies, while encouraging exports in the United States. The 7% drop in the dollar occurred despite that interest rates had more than tripled during that period. The Fed's tightening, which had started a year earlier, was insufficient in reversing or even slowing the dollar's rout, until fall 1978, when Germany and Japan assisted in mounting the biggest concerted intervention operation of the time.

Policy was again the culprit during the 1994-95 Fed tightening. The Clinton Administration's aggressive trade policy toward Japan, designed to open markets, nearly ignited a trade war. The policy's impact on the dollar was so stark to the extent that it was dubbed the "Clinton Debasement" of the dollar. When Treasury Secretary Lloyd Bentsen was asked if he wanted a weaker dollar, he said he wanted a "strong yen." Those statements sent the dollar in a speculative downward spiral, as forex traders believed the U.S. administration was conducting a policy of benign neglect toward its currency.

Another main reason for the dollar's 1994 declines were perceptions that the Fed might have been behind the curve. Non-farm payrolls averaged about 350,000 per month, inflation averaged at 2.6% (annual headline CPI) while the Fed's aggressive 50 basis point rate hikes and inter-meeting actions sent perceptions of a miscalculating central bank.

SO WHAT'S AHEAD?

It is possible that the Fed's current tightening campaign shall produce a falling dollar for the year. Aside from the geopolitical risks and earnings uncertainty, there are concerns that the U.S. economy has cooled at the early phase of Fed tightening, thereby possibly deterring the central bank from adding to the dollar's yield luster. The regular speeches by the various members of Board of Governors and presidents of the Fed district banks are sometimes as important as the FOMC meetings because they tend to signal the FOMC's emerging stance on topics such as inflation, the pace of recovery and jobs.

So far, the Fed's tightening has been aimed at normalizing monetary policy, rather than containing an overheating economy. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

The Dollar, the Fed and Foreign Inflows: Understanding How These Key Fundamentals Affect Dollar-Based Exchange Rates Can Prime You for Potential Trades and Keep You Flat When Shocks Could Move the Market against You
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.