Thanks to the Fed’s surprise rate cut, the greenback has “turned garishly green around the gills”, says Alan Abelson in Barron’s. Falls across the board have left it at a new record low of more than $1.41 to the euro and at parity with the Canadian dollar. Against a basket of six major trading partners’ currencies, it has plummeted to a 15-year low.
The rate cut lowered the yield on the dollar, so the prospect of more rate cuts as the US economic outlook darkens implies further weakness; Ian Stannard of BNP Paribas reckons the euro may breach $1.45 in weeks. But a longer-term issue is also coming to the fore. America’s ten-year Treasury bond yield ticked up by almost 0.2% last week and gold hit a 27-year high of over $730 an ounce, reflecting fears that the rate cut, along with record oil prices, could fuel inflation. The US depends on foreigners scooping up its assets to plug the gaping current account deficit.
Trust in the US authorities’ inflation-fighting credentials “is one of the pillars that support the trade deficit”, as Edward Hadas points out on Breakingviews.com. If foreigners decide they will no longer accept US securities because they are worried about inflation eroding their value, the dollar’s decline could turn into a “rout”; most economists anticipate a 30%-40% slump if this happens.
The Fed decided to err on the side of higher inflation, rather than lower growth, says Boris Schlossberg on Dailyfx.com. It has thrown “the dollar to the dogs”. The latest data on foreign capital flows, for July, shows a steep slide in demand for long-term securities, leaving the US increasingly reliant on short-term flows; this has fuelled fears that foreigners are beginning to lose their appetite for US debt. But even without this scenario, with central banks diversifying into other currencies and the trade deficit still huge, the overall downtrend looks far from over.