A strong currency has created headwinds for the U.S. economy through a range of channels. Latest actions of the Chinese central bank will intensify the negative impact by fostering more dollar appreciation. The U.S. already runs a significant trade deficit with China, and a 1.9 percent yuan devaluation announced Tuesday will further exacerbate it.
A stronger dollar weighs on U.S. growth through weaker exports, cheaper imports, devaluation of overseas profits and a sharp increase in domestic labor costs in non-dollar terms. It creates a more restrictive economic policy, thereby accomplishing the same goal as higher interest rates. In short, currency appreciation is doing at least some of the heavy lifting for policy makers, and could therefore mitigate the need for rate normalization to occur sooner rather than later. The September liftoff will be jeopardized if dollar strength continues.
