The dollar has dropped steeply this year which effectively eases monetary policy while oil has jumped in advance of Wednesday’s monetary policy decision.
The threat of more sanctions on Russia is adding to the uncertainty stemming from the trade war and the conflict in Ukraine that U.S. President Donald Trump hopes to resolve.
Economists sometimes estimate that a 10% decline in the dollar can have an effect similar to a 0.5 to 1.5 percentage point (50–150 basis points) cut in the Federal Funds rate. The trade-weighted dollar fell 6.3% between January and July. Against this backdrop it is difficult for the Federal Reserve to lower the interest rate, and the dollar’s drop and higher oil which are inflationary, will make it even harder to meet current expectations that the U.S int/rate will fall by from current 4.25% to 3.25% next year.
Inflation, which rose further above the Fed’s 2% target to 2.7% yy NSA in June, is more likely to rise further, especially with tariffs adding to the price of goods imported into the United States.
If the interest rate is cut it will add to factors already set to boost inflation. There is a growing possibility that the U.S. may have to consider ways to curb inflation, rather than fuel its rise. To do that when the president is demanding much lower rates will almost certainly result in increased tensions between him and the Fed that could fuel concerns about the central bank’s independence.
If that happens, the dollar may be sold, stoking inflation that could fuel the vicious circle in which the Fed may become trapped.
(Jeremy Boulton is a Reuters market analyst. The views expressed are his own)