Tuesday, May 5, 2015

While We Wait

The US dollar is accepted practically everywhere, and is used more than any other currency for international transactions. The US economy by most measures is still the largest and most productive economy on earth. This puts the United States in an interesting position; some might say dilemma.

When the US economy was growing at its potential and the dollar was falling, a large portion of exports generated in emerging and developing markets were either meant to be sold in the US, or processed elsewhere before being sold in the US. Inversely, those same exporters were the ones consuming the technology and intellectual property being exported by the United States. But as it currently stands, the US economy is rehabilitating from the traumatic effects of the 2008 Global Financial Crisis and resulting economic spillover. Meanwhile the dollar has been rising almost vertically for the last five years or so. This recent trend in the dollar translates to a general level of unease - - not necessarily fear - - in international financial markets. US economic data have been overall positive and improving. But with the demographic shifts that are beginning to accelerate in developed economies, along with already monumental levels of private and public debt, sources and drivers of sustainable growth are few and far between. That being said, historically the safest place has been the US dollar in times of economic uncertainty.

The current consensus is that this summer, conditions will be ideal for the Federal Reserve to begin re-adjusting its stance on loose monetary policy. This will undoubtedly be a significant signal from the Fed to US and global financial markets that the economy is once again growing on a sustainable path that can lead to a zero output gap. This signal will inevitably filter into foreign money markets and interest rates will adjust in other economies closely linked to the US. Once local prices adjust, in response to inherent sensitivity to funding costs, monetary policy in other major economies will begin to re-align as well. This scenario plays out if the signal from the Fed is reinforced by subsequent steps towards further policy tightening. This of course, can only happen if the US economy is once again growing on a sustainable path that can lead to a zero output gap.

In the meantime the dollar is beginning to consolidate, and somewhere out there, investors are positioning their portfolios for long anticipated news from the Fed on how the US economy is really doing via monetary policy signals. The Fed, in turn is waiting on signals in the economic data to discern the future of monetary policy; and in the real world, people go about their daily lives.

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