US Fed Minutes: concern over stronger dollar

The minutes from the US Federal Reserve’s FOMC meeting of September 16-17^th, added to volatility last week as financial markets initially bounced on a more dovish tone on the outlook for interest rates. However, after poor German data and the IMF downgrade of the economic recovery, investors thought more about the Fed’s comments regarding the impact of a strengthening US dollar. “Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the U.S. external sector”. A couple of participants felt that a stronger dollar “might also tend to slow the gradual increase in inflation toward the FOMC’s 2 percent goal”.

This is the possible negative feedback loop I wrote about two weeks ago, whereby a stronger US dollar, on the prospect of a stronger US economic recovery and interest rate hikes, actually hurts exports and dampens inflation, thereby delaying monetary policy normalisation. Some in the financial markets may view this as a positive, lower rates for longer, or even more QE, but in reality it would destroy any illusion of a self-sustaining economic recovery. The US Federal Reserve knows this and will be keen to avoid another backtrack on monetary policy normalisation.