Speaking of Things That Will Make the Fed’s Life Difficult – The Dollar

The foreign exchange market is understood by very few people.  Some assume that the dollar moves with the strength of the economy, some assume it has to do with rates, others still see a strong or weak currency as a sign of relative power on the world stage.  There is truth to all of that, but currencies move mostly with regard to two things: Trade imbalances and investor sentiment.  

The US Dollar has been a hot topic of discussion lately as a number of items that move currencies or are moved by currencies have acted counterintuitively.  Take for example the money supply.  During the initial phase of the pandemic, the Federal Reserve increased the money supply by nearly 40%.  Ordinarily, that type of increase (in a vacuum) would result in a declining price. 

But the dollar is measured against a basket of other world currencies.  Certainly, other currencies saw an increase in supply during that period as well, but the fact that the dollar did not fall was a shocking statement about the perceived “safety” of the greenback relative to other currencies.  

Fast forward to May of 2023 and Goldman Sachs is suggesting that the currency is overvalued by 15% and questioning the United States hegemony.  Maybe they’re right about the valuation, but we are a long way from the US losing their position as the global reserve currency.  As such, should the currency fall relative to others, a number of things will likely happen. 

First, commodities will trade higher as they are all priced in USD.  The most important financial commodities are oil and gold, but food commodities would also trade higher.  Second, as a result of commodity prices, the Fed would have to continue to raise rates. 

This does not seem like a recipe for hegemonic downfall, but it does sound like another headwind for the Federal Reserve and the US Economy in the short term.  We’re loath to make this call. 

Sources: Wall Street Journal, Northern Trust, Macrobond