Currency appreciation will cause the price of imported goods to fall, while the price of export goods will rise. Although it is not conducive to exports, it can improve the balance of payments, and currency depreciation can achieve the opposite effect.
For a strong dollar under high inflation to have a trend turning point and enter a downward channel, a landmark signal is needed. We believe that there are three major signs: First, there is clear evidence of a fall in US inflation, or a significant increase in the unemployment rate, and the disappearance of expectations for Fed tightening. We don’t think the Fed will give up tightening when there is a risk of “recession” in the U.S. economy and inflation is still high. The lessons of history make the Fed not repeat the same mistakes. Inflation-priority monetary policy should not end just because the economy is at risk of a contractionary “recession”. The second is that the Federal Reserve and the central banks of major developed economies that have signed currency swaps have started large-scale currency swaps, and there has been a phenomenon of joint intervention in the foreign exchange market. Third, the geopolitical conflict between Russia and Ukraine has reversed, and there is a definite opportunity to resolve the conflict through agreement negotiations, and global risk aversion has dropped sharply. The above-mentioned three major signs do not appear, the possibility of a trend inflection point in the US dollar index is relatively small, and the negative spillover effect of a strong US dollar under high inflation on the world economy will continue to exist.
1. Inflation in the U.S. economy has clearly fallen or the unemployment rate has risen significantly.
The U.S. Department of Labor announced on September 7 that the unemployment rate in the U.S. economy in September this year was 3.5%, a decrease of 0.2 percentage points from the previous month. The tight labor market has led to a spiral mechanism of wages and prices still existing.
The PCE of the US economy has exceeded 6% for 8 consecutive months (6.2% year-on-year in August, and the phased high was 7.0% in June), and the CPI has exceeded 8% for 6 consecutive months (8.2% year-on-year in August, with a phased high in June) 9.0%). U.S. inflation has peaked, but it continues to run at a high level. On the one hand, aggregate demand remains high due to the tight supply and demand in the labor market, and on the other hand, it is caused by supply shocks, including energy, food prices, and supply chain bottlenecks. According to a research conducted by the San Francisco Branch, as of August this year, the contribution rates of supply shock and demand pull to August PCE were 47.8% and 30.8% respectively; the contribution rates of supply shock and demand pull to core PCE were 39% and 35.3% respectively. % (Shapiro, Adam, 2022). Therefore, the factors leading to this round of inflation determine that US inflation has strong resilience.
We believe that the Fed will stop tightening only after a clear decline in US inflation rather than a single economic “recession” risk. There is a risk of “recession” in the economy but inflation does not come down, the Federal Reserve will insist on controlling circulation, and the Fed should learn the lessons of history.
In the 1970s, the United States adopted an expansionary monetary policy to combat economic recession, forming a wage-price spiral mechanism that pushed up inflation, making it more difficult to control inflation. The U.S. economy experienced two recessions in 1969-1970 and 1973-75. The Federal Reserve lowered interest rates to stimulate the economy. The federal funds rate dropped from 9.19% in August 1969 to 3.71% in March 1971; from September 1973 10.78% in 1975 fell to about 5% in late 1975. In response to the recession, the Federal Reserve continued to expand the money supply and stimulate fiscal policies, resulting in high inflation. From 1972 to 1975, the inflation rate (CPI) in the US economy rose from 3.1% to 9.2%. Against the backdrop of high inflation, the Federal Reserve has adopted a stimulating monetary policy in the face of the pressure of two economic recessions, making inflation entrenched. In 1980, when the U.S. economy experienced its third recession, the Fed was forced to lower interest rates only slightly in the middle of 1980, and continued to maintain a high interest rate state to control inflation. This was the Volcker period in history, and inflation control was almost the only goal of the Fed. , paid a huge cost, this is the “stagflation” period in the history of the US economy.
Therefore, the risk of an economic “recession” alone is not enough to make the Fed abandon its tightening policy. The Fed’s tightening expectations will disappear only when inflation clearly falls, or the unemployment rate rises significantly.
2. The emergence of large-scale currency swaps intervening in the foreign exchange market.
During the period of global financial turmoil in March 2020, the peak value of currency swaps between the Federal Reserve and nine central banks was approximately US$450 billion. Central bank currency swaps provide global dollar liquidity and have an effective regulatory effect on the foreign exchange market.
According to the latest data provided by the New York Branch of the Federal Reserve, since October, the European Central Bank and the Swiss National Bank have reached a currency swap of 206.5 million US dollars and 3.1 billion US dollars on October 5, for 7 days, and the interest rate is 3.33%. Since the U.S. dollar swaps between the Fed and other central banks are subject to interest payments, and the Fed does not pay interest, the current interest rate cost is much higher than the interest rate cost of about 2% before the global financial turmoil in 2020. Large-scale currency swaps are also a considerable cost for other central banks.
Since the Federal Reserve raised interest rates in March this year, except for the Swiss National Bank which exceeded one billion US dollars in October, the scale of currency swaps between the Federal Reserve and other central banks is relatively small. Therefore, it can be considered that as of now, there has not been a large-scale currency swap, and collective intervention in the foreign exchange market has not yet occurred.
3. The definite opportunity for the reversal of the geopolitical conflict between Russia and Ukraine.
Recently, the European Union has introduced the eighth round of sanctions against Russia, and the United States has also recently introduced new sanctions against Russia. The geopolitical conflict between Russia and Ukraine is at risk of further escalation, and there is no sign of a reversal of the conflict yet. If the geopolitical conflict between Russia and Ukraine intensifies, this will further amplify the safe-haven nature of the US dollar and push up the US dollar index.
When the geopolitical conflict between Russia and Ukraine is reversed, the safe-haven property of the US dollar will decline significantly, which will drive the US dollar index down.
The U.S. inflation has clearly fallen or the unemployment rate has risen significantly, other central banks of the Federal Reserve have started large-scale currency swaps to jointly intervene in the foreign exchange market, and the definite opportunity for the reversal of the geopolitical conflict between Russia and Ukraine is the turning point of the trend of the U.S. dollar index at this stage. Three iconic signals. If neither occurs, the possibility of a trend inflection point in the U.S. dollar index is relatively small, and the negative spillover effect of a strong U.S. dollar under high inflation on the world economy will continue to exist.