Column: Far from debasement, the dollar is racing: Mike Dolan


A bundle of US five dollar bills is inspected at the Bureau of Engraving and Printing in Washington on March 26, 2015. REUTERS / Gary Cameron / File Photo

LONDON, Nov. 12 (Reuters) – Wasn’t soaring inflation supposed to undermine the US dollar?

Either way, the opposite happened this week as news of a surprise spike in U.S. inflation and inflation expectations to their highest level in decades pushed the U.S. dollar up. against currencies around the world.

The main dollar index (.DXY) hit its highest level of the year as the euro and pound sterling, which represent 58% and 12% of this index respectively, fell to their lows of 2021 .

To some, it made little sense.

There is a long-standing narrative that the Fed’s money too easy and the seemingly endless creation of new dollars through the purchase of Fed bonds will end up fueling inflation and undermining the greenback as a backbone of the global financial system.

All other things being equal, higher consumer inflation should be bad for a currency because it means people can buy less goods and services for their coin. Left to fester, soaring prices and the resulting hyperinflation have in the past rendered national currencies effectively worthless.

Fear of the so-called “dollar depreciation” has been the stuff of gold bulls for decades, and many have called for a return to the gold standard since its abandonment 50 years ago. Lately, cryptocurrency evangelists have taken over.

Still, bitcoin or ethereum’s failure to be excited by Wednesday’s U.S. inflation shock underscored how uneven the argument for buying crypto as a hedge against inflation remains.

And while gold has risen this week, it remains in the red for the year. Long-standing gold bugs and Fed critics such as Euro Pacific Capital’s Peter Schiff have questioned why the dollar was going up.

“The dollar’s rise today makes no sense,” Schiff tweeted Wednesday. “The fact that the dollar is losing purchasing power much faster than expected does not make the dollar more valuable.”

So what gives?

Prosaically, everything is relative. Even if confidence in the Fed is called into question, forex dictates that any loss in the bank’s credibility only matters if it is higher or lower than that of any other central bank.

And more posaically still, it all comes down to the basics of where you expect US interest rates and inflation to be relative to their major peers a year from now.

Fed rate expectations and the dollar
Economic surprises euro / US and euro / $


This week’s drop in the global euro / dollar hub pair to its lowest since July 2020 came as the one-year interest rate differential in favor of the dollar widened after inflation data. It has now added nearly 20 basis points to 0.9% in just three weeks.

The Fed now plans to hike its key rates at least twice by the end of next year, starting in July. The European Central Bank barely forecast a smaller hike, but ECB officials strongly insist that a rate hike next year is highly unlikely.

It is less obvious that these rate premiums cover expected inflation differentials. They are shy over a one-year horizon – but they seem to comfortably hedge the risk over a 5-10 year outlook, judging by the relative inflation swap market.

And more immediately, the US economic data surprised consensus forecasts more positively than the still deeply negative surprises observed in the euro zone. In fact, the spread between Citi’s compiled US and Euro economic surprise indices is more positive in favor of the United States than at any time since October of last year.

Even though Fed critics like Schiff doubt the Fed is willing to tighten as far as the market now thinks, more mainstream investors believe the Fed will react next year and that there are many more margin to reassess these expectations higher than for other central banks. .

Leandro Galli, senior portfolio manager in Amundi’s global bond team, believes the market is not yet fully valued for higher long-term US inflation or the degree to which the Fed will act to contain it .

“The longer the Fed waits, the faster it will have to move forward.”

Is galloping inflation today the beginning of a great “degradation” or the incentive to better returns?

There are a myriad of arguments as always.

What he recalls is the sometimes tedious debate over the alleged “strong dollar” policy of the US Treasury – a severed mantra that “a strong dollar is in the interests of the United States”, which the former Treasury Secretary Robert Rubin reiterated in the 1990s to push back questions about whether Washington weakened the dollar for a trade advantage.

Subsequent Treasury Secretaries often got tied up over wording – often recklessly qualifying the statement as to whether it simply meant a strong dollar in your pocket via low inflation or strength in global currency markets.

This week at least, it is most certainly the latter.

Euro / US and Euro / $ rate spread
Euro / US and euro / $ real rate differentials

by Mike Dolan, Twitter: @reutersMikeD; Editing by David Clarke and Steve Orlofsky

Our standards: Thomson Reuters Trust Principles.

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