The Federal Reserve may be on the brink of a huge mistake if it decides to retreat from the global currency wars.
So goes the warning implicit in the statements of behemoth investors like billionaires George Soros and Ray Dalio. They're worried that it's way too soon for the Fed to simply give up and steadily raise interest rates. Just the thought of a rate-increase cycle has caused the dollar to surge almost 20 percent since June 2014 against a basket of 10 leading global currencies, eroding earnings for North American companies such as Johnson & Johnson, Procter & Gamble and Apple.
Currency fluctuations lowered earnings for the average North American company by 12 cents a share in the third quarter, according to FiREapps data reported in a Bloomberg News article. What would have been $100 in sales in the fourth quarter of 2014 is now worth only $85 because of the shift in currency-exchange rates, Apple said in a statement this week.
If the Fed allows the dollar to keep rallying, it may derail any fragile recovery that the world's biggest economy can muster. While Alan Greenspan's Fed tried to be blind to international currency dynamics, Janet Yellen's Fed can't afford to ignore them.
The dollar's surge has arguably been the most notable effect of the Fed’s decision to start tightening monetary policies and the expected slow but steady upward trajectory of overnight borrowing costs.
While the overnight benchmark rate typically sets a tone for longer-dated bonds, it hasn't done that at all this time around. Quite the opposite -- yields on 10-year and two-year Treasuries have fallen since the U.S. central bank's December interest rate increase, and a gauge of longer-term inflation expectations has plunged to about its lowest since 2009.
And while yields on corporate bonds have risen, that began well before policy makers took action and had as much to do with falling oil prices and rising default expectations as monetary policy.
The rate increase did, however, add a little extra fuel to the dollar's gain, especially as the European Central Bank, Bank of Japan and People's Bank of China all signaled they were moving in the opposite direction and adding to stimulus. This has had a direct effect on companies that drive the American economy.
"It is best for the world and for the U.S. for the Fed not to tighten,'' Dalio, founder of hedge-fund firm Bridgewater Associates, wrote in an article this week in the Financial Times.
The Fed did not rule out a March increase on Wednesday, and its decision-making in the short term may have less to do with bond yields than it does the dollar. And some of the biggest investors would like to see the U.S. central bank stay in the currency wars and wage a fight to devalue the dollar.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
(Updates last paragraph with Federal Reserve decision.)
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