Economics and investment report: finding shelter in a currency storm

Despite escalating global trade tensions and anxiety about the risks of recession, the US economy continues to put in a decent performance. Growth remains steady if not spectacular, and the tighter labour market is finally producing earnings growth. But US outperformance has consequences—and Donald Trump is not pleased with them.

Over the past months, Trump has frequently taken to Twitter to complain about the strength of the US dollar and castigate Federal Reserve chair Jay Powell (a Trump appointee) for not easing policy fast enough. In the strange world of 2019, Trump’s Twitter feed can move markets. The question investors have to ask is: do his tweets signal a change in policy, or is he just venting? Trump is certainly barking loudly, but that doesn’t necessarily mean he will bite.

Since the mid-1990s, the official US position has been that a strong dollar is good for America. It keeps inflation in check by reducing import costs, encourages foreign investment and helps maintain the central role of the dollar in international finance. Yet Trump has a myopic focus on the US trade deficit and argues that a strong dollar is holding back exporters, while allowing imports to pour into the US.

On Twitter, Trump responded to the European Central Bank’s easing of policy in June by complaining that it “immediately dropped the euro against the dollar, making it unfairly easier for them to compete against the USA.” But the US has enjoyed a fuller recovery from the 2008 crash than many of its peers. This is what has led to higher interest rates than in most developed economies. Even though the Fed has now begun to cut rates, the yields available on US debt still look attractive to overseas investors. That’s putting upward pressure on the dollar, as money has flowed towards where a safe return is available. It’s not just developed currencies against which the dollar has strengthened. In August, the value of the Chinese Yuan fell below seven to the dollar—a level seen as symbolically important. The US responded by branding China a currency manipulator.

The growing fear is that the president may intervene in the currency markets to push the dollar down. There are several problems with this approach. First, it is not obvious that the dollar is overvalued and certainly not at the level which prompted intervention in the past, for example in the 1980s. Second, those efforts were multilateral, with co-ordinated intervention in foreign exchange markets for the good of the global economy. What the current administration seems to be pondering is very different—unilateral action to weaken the dollar and grab export market shares from competitors.

The US Treasury is legally responsible for managing exchange rate policy, but in every previous intervention the Fed has acted alongside it. Which leads to the third problem: the Treasury has foreign exchange reserves of “just” $126bn. Daily trading volumes in dollars/euros are north of half a trillion. The Treasury simply lacks the firepower to intervene effectively unless the Fed acts with it, yet this is something Powell seems very reluctant to do. Indeed, any intervention could lead to a flare-up in tensions between the White House and the Fed, and more questions over central bank independence.

It’s hard to know how seriously to take Trump’s threats. Cooler heads might still prevail. But investors are probably well served by maintaining exposure to gold, a likely beneficiary of any flight to safety if Trump does pull the trigger.

Read Andy Davis on the uncertainty facing investors