Q4 2018 New Markets Investor

Q3 2016
The USD will remain in demand for
some time to come
Simon Derrick,Chief Currency Strategist
BNY Mellon
One of our core beliefs is that the US adopted a policy
of ‘benign neglect” towards the US dollar (USD) somewhere
in late 2001/early 2002 Indeed, the idea that the
US might be prepared to follow such a policy had been
publicly expressed as early as October 2004 by Japans
former vice-finance minister for international affairs,
Eisuke Sakakibara. He told Dow Jones Newswires that
a “surprisingly large “number of current and former
government and central bank officials he had recently
met in Washington and New York seemed to hold the
view that some sort of foreign exchange adjustment:
could be used to address the US twin current account
and budget deficits. He added that Washington might
choose to tolerate a USD fall in a form of “benign
neglect:’ even without explicitly saying that was what it
was doing. Whether or not the US did choose to follow
a policy of benign neglect towards the USD is, in our
opinion, in some ways, irrelevant.
What does matter is that between the start of 2002 and
the summer of 2014 the targeted Fed Funds rate on
average lagged behind the headline inflation rate by 64
basis points (bp). This stood in sharp contrast to the 294
bp average pick up afforded during the Rubin era of the
strong USD that began in the late 1990s.
At its most extreme (September 2011) the Fed Funds
rate stood an astonishing 361 bp below the inflation
rate, a level only previously seen back in 1975.
The impact on the USD was straightforward with the
trade-weighted index falling 38% between the start
of 2002 (when the Fed Funds rate stood 60 bp above
inflation) and the start of September 2011.
The impact of this sustained USD decline on commodities
such as oil and gold, and on a wide range of
currencies was dramatic but easy enough to understand.
Gold rallied by close to 500% against the USD over this
period while Brent Crude gained over 400% (with the
largest gains coming whenever the US looked to ease
monetary policy aggressively). Equally, the FX reserves
of many emerging and developing nations soared as
they either stepped into the market on a regular basis to
fight against currency strength or enjoyed the benefits
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New Markets Investor