NEW YORK (Reuters) - The strength of the U.S. dollar has long been a thorn in President Donald Trump’s side. That has put the almost unthinkable scenario of currency intervention up for debate in global foreign exchange circles.
Forcibly halting the U.S. dollar’s strength would be a drastic step, not deployed in more than three decades.
The last big concerted effort to weaken the dollar was after the Plaza Accord in 1985 when five of the largest industrialized countries agreed to act to bring down the value of the dollar.
Most recent FX interventions by policymakers in developed economies have been to address currencies getting out of whack from historical exchange rates or to counter disorderly markets.
Analysts agree that while the possibility of a unilateral intervention in currency market by the United States is low it is not completely unthinkable.
“I think with this administration the mantra always has to be ‘everything is on the table’,” Gennadiy Goldberg, senior interest rates strategist at TD Securities, told the Reuters Global Markets Forum on Tuesday.
For the moment, however, the administration does not appear eager to take that path. Treasury Secretary Steven Mnuchin on Wednesday told Bloomberg Television he did not intend to intervene in the market for now.
Currency intervention refers to the practice of a country’s monetary authorities buying or selling their own currency in the foreign exchange market with a view to steering its value.
This is usually done to curb volatility and lend stability to a currency. A number of countries, including Japan, Switzerland, and China have in the past intervened in currency markets.
The United States’ most recent intervention in currency markets was in 2011, when it joined other countries in a concerted intervention to weaken the yen after the Japanese currency appreciated sharply following a massive earthquake in Japan.
The U.S. Treasury and the Federal Reserve generally collaborate on foreign exchange intervention decisions.
The president has several tools at his disposal if he wants to curb the strength of the dollar.
1. Exchange Stabilization Fund
Trump’s biggest weapon is the Exchange Stabilization Fund (ESF) which is operated by the secretary of the Treasury with the approval of the president, without the need for approval of the legislative branch. It was created in the 1930s to stabilize the exchange value of the dollar.
As of July 31, the ESF had $93.77 billion in assets that the Trump administration could deploy to buy and sell foreign currencies. That included $20.68 billion in foreign currencies, $50.49 billion in Special Drawing Rights, and $22.60 billion in U.S. government securities.
Additional funds can be generated by ‘warehousing,’ where the Fed and the U.S. Treasury swap foreign-currency holdings.
In addition to these funds, the Fed has traditionally matched Treasury intervention funds, thus essentially doubling the Treasury’s firepower. In principle, the Fed could also expand its balance sheet beyond that to buy foreign assets and other countries could agree to join the United States in the intervention.
Taking all of this into consideration, Citigroup strategists said U.S. firepower for an intervention is potentially unlimited, but realistically up to around $200 billion to begin with.
Tighter Federal Reserve policy has been one of the significant drivers of the dollar’s strength. While there are legislative hurdles to tweaking the Fed’s mandate, Trump could continue trying to influence the Fed by publicly pushing Fed Chair Jerome Powell to cut rates faster.
For a president, Trump is unusually vocal about the strength of the greenback. He has repeatedly called for a weaker U.S. dollar in a bid to help U.S. exporters and could continue to talk down the dollar.
“U.S. President Trump has actively used verbal intervention this year in an effort to push down the value of the U.S. dollar. His efforts, however, have been largely unsuccessful,” Jane Foley senior FX Strategist at Rabobank, said in a note.
4. PRESSURE TRADING PARTNERS TO STRENGTHEN THEIR CURRENCIES
As the United States renegotiates trade deals with various trading partners it could pressure them to strengthen their own currencies by adding currency clauses to any new trade deals, analysts said.
For now, currency intervention is seen unlikely. But it could become a possibility if the dollar rises significantly further.
“Recent comments by U.S. policymakers suggest that FX intervention is off the table for the time being. We agree,” BofA Merrill Lynch Global Research strategists said in a note.
“The dollar needs to be stronger in disorderly conditions to warrant a response,” they said.
EURUSD would likely need to decline into the 1.05 - 1.07 zone by September before a potential intervention would start to look justified in the context of history and international commitments, the strategists said.
Citi FX strategists also see the chances of intervention rising if the dollar strengthens about 10% further, with the risk of intervention becoming acute around EURUSD at $1.05.
GRAPHIC: EUR/USD - here.jpg
“This would go against the grain of years of G7 accords which maintain that markets should set exchange rates,” Rabobank’s Foley said.
Even if the United States were to intervene in FX markets, analysts doubt whether that alone would be enough to stymie the dollar’s strength.
“The effectiveness of such an intervention is something I would question - the U.S. has limited capacity to intervene and can create perverse feedback loops,” TD Securities’ Goldberg said.
“For example, during the U.S. downgrade in 2011, Treasury yields actually declined. If a U.S. intervention, which we don’t expect, ends up triggering a global risk-off, we could perversely see the U.S. dollar strengthen instead of weaken,” he said.
Strategists at Citi expect a U.S. FX intervention would weaken the greenback by 2-3% over the first few day, they said in a recent note. The medium-term impact could also be substantial but is more uncertain, they said.
Overall, analysts are skeptical about the success of such a move.
“History suggests currency intervention only works when accompanied by shifts in relative monetary policies and coordination across nations,” Dario Perkins, managing director, global macro at TS Lombard, said in a recent note.
“The conditions for coordination do not exist today and unilateral U.S. attempts to force the dollar down could get messy,” he said.
Reporting by Saqib Iqbal Ahmed; Additional reporting by Gertrude Chavez-Dreyfuss and Richard Leong in New York and Aaron Jude Saldanha in Bengaluru; Editing by Megan Davies, Andrea Ricci and Tom Brown