In an short interview with CNBC Prof. Roubini is asked about his expectations on the value of the U.S. dollar.
Roubini says he doesn’t expect much change for now, because the economies of Japan and Europe are slowing down and that will lead to expectations of interest rate cuts in Japan and Europe.
One often sees this argument in the U.S. centric financial media. Last week the Dollar bounced off a record low of $1.60 per Euro to $1.5630. This promptly led to false analysis.
"The dollar will continue to rebound," said Benedikt Germanier, an analyst at UBS AG in Stamford, Connecticut. "The Fed has the bulk of its easing behind it, while the ECB has the bulk of its easing ahead of it."
Europe is really not insulated and its economy is beginning to show signs of a slowdown," Meadows, [a market analyst at Tempus Consulting in Washington,] said. "While most people now believe the Fed is about to end its easing cycle, a growing number of investors believe the ECB may have to start cutting rates really soon."
These people are wrong. Sure, differences in interest rates are one reason for Euro preference by investors, leading to a decline of the value of the dollar. It is also correct that the economy in Europe is slowing down. But the European Central Bank will not cut interest rates and any expectation of such is mistaken.
While the Fed’s monetary policy has by law two equal and often competing objectives, maximum employment and stable prices, the ECB has, also by law, a hierarchy of objectives with overriding importance assigned to price stability. U.S. commentators seem not to understand this.
In the current inflationary climate the ECB can not and will not cut rates, while the Fed will likely cut at least another 0.25%. The ECB may well increase its interest rate even in an economic downturn and despite the usual protests from Sarkosy and others.
My expectation at this point is that the dollar slide will pause a while, until a second phase of this recession will hit the markets. Roubini and Pimco’s Mohamed El-Erian also expect a second downturn wave. The later writes:
Economic data in the US have taken a notable turn for the worse.
Most importantly, the already weakening employment outlook is being
further undermined by a widely diffused build-up in inventory and
falling profitability.
…
It is thus too early to declare the end of the turmoil that started
last summer. Instead, during the next few months we may witness a new
phase of dislocations, led this time by the real economy.
So far the downturn has been mostly in the leveraged finance realm. But as soon as the one time and small effect of the debt financed $30 billion economic stimulus checks is vanishes, the real economy will turn down sharply.
70% of U.S. GDP is depending on consumer spending. The very real downturn in spending has still to hit home. The slight uptick in U.S. exports will not cancel that effect. The Fed will then be urged to ease even more, while the ECB will be in raising mood. El-Erian again:
The sharp slowdown in the US real economy will occur in the context of continued global inflationary pressures. As such, the Federal Reserve’s dual objectives – maintaining price stability and solid economic growth – will become increasingly inconsistent and difficult to reconcile. Indeed, if the Fed is again forced to carry the bulk of the burden of the US policy response, it will find itself in the unpleasant and undesirable situation of potentially undermining its inflation-fighting credibility in order to prevent an already bad situation from becoming even worse.
The dollar will thereby fall again after having taken a small pause. To hope that the ECB will intervene and rescue the dollar by lowering rates is mistaken. There will be a lot of harsh words crossing the Atlantic over this, but the laws and facts will not change.
