The dollar continued its week-long slide against the euro just one day before the next Federal Open Market Committee statement and investors are strongly of the belief that the FOMC will maintain the current low interest rate policy capping the Federal Funds rate at just 0.25 percent.
A low interest rate tends to devalue a currency; this is because lower interest rates mean weaker yields for investors. As a result, investors will sell lower-yielding currencies for currencies providing higher returns and this exactly what has been happening with the dollar. Looking ahead, the dollar sell-off will likely increase as the interest rate gap between the U.S. and other countries continues to widen with rate increases in Australia, Canada, and most recently the Eurozone, taking the shine off the greenback.
Geithner Pledges Support for Strong Dollar
Regardless of the high probability that the Fed will maintain the historical low Federal Funds rate – an action that continues to encourage a weaker currency – U.S. Treasury Secretary Timothy Geithner today repeated his earlier mantra that the Treasury believes in promoting a strong U.S. dollar.
“Our policy has been and will always be, as long as I will be in office, that a strong dollar is in the interest of the country,” Geithner said at a New York conference earlier today. “ We will never embrace a strategy to weaken the dollar.”
Based on Geithner’s comments, it is clear that the Fed and the Treasury Department are not – publically at least – reading from the same playbook. In fairness, the Fed is “independent” of the government with a mandate to ensure full employment while promoting sustainable growth and it is the Fed’s ability to set interest rates that makes it possible for the Fed to achieve these goals.
Nowhere does it say that the Fed is responsible for maintaining the value of the dollar. In fact, considering its actions in the wake of the last recession, it appears a weaker dollar is exactly what the Fed is working towards.
Not that this is necessarily a bad thing at this time. A weaker dollar is beneficial for exporting companies as it helps make products made in America more affordable for foreign buyers. For example, recent earnings reports from large multinationals such as IBM and Intel were bolstered by surging global demand for their products. Certainly, these companies make good products, but so do other manufacturers but having a discounted dollar has helped foreign sales. If demand continues to grow, this could translate into employment gains for American workers.
So, while Geithner continues to pledge his allegiance to a strong dollar, look to Bernanke and tomorrow’s statement from the Fed for a realistic picture of America’s real fiscal policy. Also, keep in mind that Geithner is more politician than economist and it would not be very politically astute for him to announce publically that a weak dollar is his objective. Bernanke has proven he has no such qualms.
Scott Boyd is a regular contributor for the OANDA MarketPulse FX blog.
