The U.S. Dollar Index (DXY) took a dive last Friday following a middling jobs report. Could the move be the start of a bigger breakdown?
The DXY, a measure of the dollar’s relative strength versus a basket of foreign currencies, peaked in late September. Since then it has fallen into a sideways trading range, failing to make new highs despite another jumbo rate hike by the Federal Reserve last week.
Currency traders may be looking ahead – specifically to the likelihood of a U.S. economic downturn in 2023. The potential of another housing-led Great Financial Crisis also looms.
The full effects of the Fed’s latest rate hike won’t be known for months, but higher borrowing costs will hit struggling consumers, prospective home buyers, and small businesses.
The pain of higher debt servicing costs will also be felt by politicians in Washington, D.C. Many are now begging Powell to back off on further rate hikes.
Democrat Senator John Hickenlooper wrote a letter to Fed Chairman Powell recently to “urge the Federal Reserve to pause and seriously consider the negative consequences of again raising interest rates.”
“There are causes of inflation beyond the amount of money in circulation,” Hickenlooper continued. Of course, all other “causes of inflation” are exacerbated by loose monetary policy!
Joining Hickenlooper last week in a team effort to pressure the Fed were several U.S. Senators and Members of Congress, including Elizabeth Warren, Bernie Sanders, and Rashida Tlaib. They all signed a letter telling Powell they are “deeply concerned that your interest rate hikes risk slowing the economy to a crawl.”
Powell ultimately rejected their pleas. In comments following the Fed’s 0.75% rate hike, he said, “It is very premature to be thinking about pausing… incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected.”
Currency and precious metals markets defied Powell’s hawkish tone with sharp moves in last Friday’s trading. Traders seem to be getting the sense that Fed officials are, in fact, thinking about pausing in the near future.
If they had paused before the election, they would have been perceived to be bending to political pressure. The Fed carefully crafts an institutional image for itself as being “independent” of politics – even though it is ultimately a creature of politics.
If the Fed continues to resist political demand for loose monetary policy, it risks the Biden administration moving to replace Fed policymakers or Congress taking direct action to expand the currency supply itself.
Political demand for low interest rates won’t abate regardless of the outcome of the upcoming election.
Historically, whichever party is in power tends to lead the push for easy money. When Donald Trump was President, he repeatedly tried to pressure the Fed into pursuing looser monetary policy – just as Democrats are doing now.
It appears likely that divided government will return to Washington, with Republicans controlling at least one chamber of Congress while Democrats retain control of the executive branch.
With partisan acrimony running high, one of the few areas of common ground will be the desire to keep federal finances afloat through low-interest borrowing.
Democrats are unlikely to agree to any spending cuts. Republicans are unlikely to agree to major tax hikes.
But the establishment wings of both parties can agree on the need to borrow a lot more currency into existence while somehow holding down the government’s debt servicing costs.
Once the election is out of the way, Powell may decide it’s time to pivot away from jumbo rate hikes. Even a hint of a pivot or a pause could trigger a breakdown in the U.S. Dollar Index and liftoff for gold and silver markets.