Janet throws hot potato to Mario There is one thing all central bankers want to avoid right now – a strengthening currency. In the September 18 decision to leave the funds rate unchanged, the Fed statement noted softness in net exports and declines in non-energy import prices. These factors partly stem from dollar strength. As a result of the Fed decision, the euro strengthened.
This means that Mario Draghi now holds the hot potato and will have to pass it on by urging the ECB to act. Meanwhile, eurozone economic forecasts and earnings expectations are likely to be downgraded and the stock market is likely to underperform. While the dollar has not strengthened all that much, barely 2 percent in tradeweighted terms since the July FOMC meeting, it was still a factor weighing against a hike in September. The Fed noted that net exports had been soft and that nonenergy import prices had declined.
Clearly, the strength of the dollar has been a contributing factor to these developments. The Fed decision not to hike in September was to a large extent priced into US interest rates, but even so there was a strong reaction. Yields fell for all maturities. The two-year yield dropped 12 basis points. As a result, the dollar dropped immediately against major currencies.
The euro surged from below 1.13 in European trading to close around 1.1440 Thursday evening. This is unwelcome news for the ECB. At the press conference following the September ECB meeting, Mario Draghi warned that risks for growth and inflation were on the downside. Following those comments, the EUR/USD dropped below 1.11, which was probably what he wanted.
