Fed looking at a very different dollar than Wall Street
By many popular measures, the dollar has traded sideways for the last six months. Then there's the Federal Reserve's measure. The greenback is surging, according to an index the Fed created to track the U.S. currency versus 26 of the country's biggest trading partners. It's risen 1.3 percent beyond a 12-year high reached in March, when the central bank fired the first of a series of warnings that a stronger dollar may hurt growth and lower inflation. At a time when the Fed's tightening path has become one of the biggest drivers in the $5.3 trillion-a-day foreignexchange market, the discrepancy between Wall Street's view -- largely based on the dollar's performance against the euro and the yen -- and that of policy makers may lead to a jolt for investors expecting recent ranges to persist.
The rapid trade-weighted appreciation this quarter has come mostly against big exporters such as China and Mexico, and it undercuts the Fed's goal of quicker inflation. It may trigger further jawboning from officials looking to cool the dollar's broad gains as the Fed begins raising interest rates for the first time in almost a decade. "The dollar still continues to strengthen on a trade-weighted basis and the Fed definitely takes that into the equation,'' said Brad Bechtel, a managing director at Jefferies Group LLC in New York. ``The risk is the Fed starts really emphasizing that, and the market would be caught offside.'' The Fed's tradeweighted broad dollar index measures the greenback against the currencies of 26 economies according to the size of bilateral trade. China, Mexico and Canada make up 46 percent of the gauge.
Meanwhile, most private-sector dollar gauges track a basket of the world's most liquid, widely used currencies. Intercontinental Exchange Inc.' s U. S. Dollar Index, which serves as the benchmark for various futures and options instruments, has a 58 percent weight to the euro and 14 percent for the yen. It lacks representation from any emerging markets, which account for more than half of the U.S.'s total trade flow.
The two indexes had moved alongside each other until a month ago. The Fed's broad dollar index surged 3.4 percent this quarter to a 12-year high as China devalued the yuan to support a slowing economy, while a renewed commodities rout undermined Canada's loonie and the Mexican peso. The ICE dollar gauge dropped 0.7 percent during the same period.
``It's important to be mindful of which dollar measures matter, especially if you're looking at it through the Fed's eyes,'' Ellen Zentner, chief U.S. economist at Morgan Stanley, said on Bloomberg Radio. One of the criteria for the Fed to raise rates is ``a leveling out of the tradeweighted dollar. At the time of the June meeting, they could check off that box. Today, they can't.'' Dollar bulls as recently as March were buffeted by unexpected warnings from the central bank.