The US dollar is at war with the Fed

As global currents lift the US dollar, Federal Reserve speakers are fuelling -- rather than fighting -- the unit’s strength.

The strength of the US dollar is making it harder for the economic recovery in the US to gather more momentum, but rather than engage in a currency war with other central banks it seems the Federal Reserve Bank is at ease with the situation. I would find it hard to believe the Fed doesn’t know there is a war on at the moment when over the past two years the greenback has gained almost 40 per cent against the yen -- 4 per cent in the last month alone, while in trade with the euro it is up some 9 per cent since May.

While the main causes for these moves are due to the actions of the Bank of Japan and the European Central Bank, the market's anticipation of tightening monetary policy from the US Fed has exacerbated the strength of the US dollar.

Fed speakers add fuel to the fire

Overshadowed by the usual noise accompanying the US employment report on Friday, four voting Federal Reserve bank members spoke at various venues. So too did Philadelphia Fed member Charles Plosser over the weekend and it was his comments, with his rather direct view on interest rates, that captured the most headlines. He said as the economy moves closer to the Fed’s goals, keeping interest rates near zero was a “risky strategy”. Adding fuel to the greenback's fire, Plosser prefers they start to “raise rates sooner rather than later,” reinforcing the market's hawkish view on US interest rates.

Richard Fisher, the Dallas Federal Reserve bank member, put one of the Fed’s aims rather succinctly when he said “a central bank is first and foremost charged with maintaining the purchasing power of its country’s currency”-- hardly fighting words from the Fed. He went on to point out that the price of some components of core services, such as rent and household meals, increased at “the fastest rates” in a while, again sitting on the hawkish side of the fence.

Graph for The US dollar is at war with the Fed

                                                                                    Source: Federal Reserve Bank of Dallas

                       

The times they are a-changing

With the asset purchasing program due to conclude in October and the FOMC meeting scheduled for next week, to be followed by its bi-monthly press conference, the timing is right for a change in rhetoric. I don’t think you can get much clearer signalling than what we got from Plosser over the weekend, when he added, in reference to borrowing costs staying low for a “considerable period of time", that “this language is no longer appropriated or warranted”.

In this context it is likely the greenback could extend gains even further. And it appears the Fed knows there isn’t much it can do about it.

Jim Vrondas is chief currency strategist, Asia-Pacific at OzForex, a global supplier of online international payment services and a key provider of Forex news. OzForex Group Limited is a publicly listed entity with shares traded on the Australian Securities Exchange under the code "OFX".