US dollar's global role and Fed policy

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Almost 70 per cent of world central bank reserves are in dollars.
Almost 70 per cent of world central bank reserves are in dollars.

French President Giscard d'Estaing called the US dollar's global role an "exorbitant privilege". True.

By Matein Khalid

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Published: Mon 1 Aug 2016, 12:00 AM

Last updated: Mon 1 Aug 2016, 2:00 AM

The US Dollar replaced sterling as the world's reserve currency at the end of World War Two, which destroyed both the British Empire and the Third Reich. The advent of the Cold War, the reconstruction of postwar Europe under the Marshall Plan, the Bretton Woods monetary regime and the emergence of US multinationals on the world stage amplified the global role of the US dollar. The world oil market is denominated in dollars. 70 per cent of world central bank reserves are in dollars. The IMF and the World Bank loan money in dollars. Brexit, Japan's lost decades, the Chinese Politburo's obsession with capital controls and multi-trillion dollar offshore syndicated bank loan/debt markets all make the US dollar the reserve currency of our lifetime. This is the reason why, even as oil prices crashed, the GCC retained its currency peg with the US dollar in 1986, 1999, 2008 and 2015.
French President Giscard d'Estaing called the US dollar's global role an "exorbitant privilege". True. The US attracted the savings of China, Japan, the Asian tigers, the Arab world and the flight capital of Third World coffee to copper satrapies to finance the greatest consumption binge in the history of capitalism despite a chronic savings glut. American money centre banks dominate international finance and American oil companies global energy markets. Foreign holdings of US Treasury bills, notes and bonds "subsidise" US dollar interest rates. Like imperial Rome two millennia ago and Britain prior to 1939, the US enjoys Lord Keynes's idea of monetary seigniorage since it alone can accumulate external debt indefinitely in its own currency. It is surely no coincidence that the US dollar has lost 96 per cent of its external value since the creation of the Federal Reserve in 1913. Switzerland has not been invaded since the time of Napoleon but negative Swiss franc interest rates (and the end of Swiss banking secrecy after 9/11) means that the world's only real safe haven is the US economy, the US banking system and the US dollar.
The Yellen Fed stated clearly in its statement that "near term risk to the economy have diminished" even though it kept the Fed Funds rate on hold. This gives the "data dependent" US central bank time to assess the economic data momentum and the financial markets until the next FOMC conclave on September 20/21, after the global central banker jamboree in Jackson Hole, Wyoming. It is significant that the July FOMC has acknowledged "labour markets have strengthened", something that was absent in June. Since June payrolls rose 287,000, the FOMC had no other choice. The post Brexit surge in financial assets and fall in volatility also give the Federal Reserve room to raise rates in September. After all, strong payrolls, retail sales, new stock market highs, Volatility Index at 12 all mean that the risk of a September rate hike will continue to rise in the next six weeks.
The Fed Funds futures markets predict a 45 per cent probability of a 25 basis point rate hike by December. This could explain the reason why the ten-year US Treasury bond yield fell from 1.51 per cent to 1.45 per cent after last week's FOMC and the US dollar slipped in the currency market. The currency markets have obviously concluded that the Federal Reserve will not move till December, if at all in 2016. Yet I believe the strong economic data/lack of capital market stress/wage inflation deterrents to a Fed rate hike have all gone. It is fatal to assume that the US election season alone precludes a Fed rate hike.
The Bank of Japan disappointed the market with its scale of easing and Kurodo-san obviously does not have the political capital for another "shock and awe" QE. Expect the Japanese yen to make another short term high to 102.
The fall in crude oil, asymmetric growth and interest rate spreads made the Canadian dollar a short at 1.25 and I can easily envisage the loonie to depreciate to 1.36 if the Fed hikes in September while West Texas crude falls to $38.
Weak French GDP, German retail sales and Italian CPI mean that it will be difficult for the Euro to escape short term bearish pressure in August, possibly down to 1.08. Planet Forex is agog that Egypt will soon sign a loan deal with the IMF, despite the previous two debacles. Egypt's credit default swaps have fallen to 450 basis points. The subsidy cuts, VAT and devaluation all make a three year IMF loan probable as it is mission critical for a new Egypt sovereign Eurobond.
Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at: matein@emirates.net.ae


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