Fed can't feed the dollar beast

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Welcome to Hard Currency, the weekly Financial Times podcast on the foreign exchange market. I'm Roger Blitz. And the week has been dominated by the Federal Reserve, which, as predicted, said it would begin trimming its balance sheet and stuck to its interest rate predictions.

So what did the market make of it? Well, the dollar rose about 1%. That was the reaction. The question is is that a big deal or is it, frankly, a lot of fuss over not much? Our guest this week is Peter Rosenstreich, Foreign Strategist at the online bank, Swissquote. Peter, what did you make of the Fed, first, and the dollar reaction, second?

We thought, pretty much, it went lock and step. We had expected a slightly more hawkish Yellen. So we were on the right side, but probably expected a little more hawkishness out of her. In terms of the dollar reaction, I think it's still very much up in the air in terms of whether this is going to be a trigger for further dollar appreciation or it's just a knee jerk reaction to comments.

And if you look at the emerging market currencies, yes, the dollar did very well against low yielders in the G10, but against EM, things like the ruble, the gains were not as stark. So I think the fact that we didn't see a rotation out of high beta currencies, basically, tell us that it's not going to be an end of the carry trade and yields seeking. and more of a short term blip.

Which in some respects, the lack of a major reaction in the market is surprising, considering what she's effectively saying about inflation. Do you remember when the Fed couldn't move because of the worries about inflation, as other central bank [INAUDIBLE]? And yet, here she is saying, do you know what? The data isn't so important anymore. That, at face value, is actually quite significant, isn't it?

I think so. I think this goes to what we believe is the root of the desire of the Fed is not so much their concern about, or the current concern about inflation, but also getting off these extreme emergency type of policy. Yes, they've been hiking for almost two years now.

They're slowly moving off the floor. They are now ready to reduce their balance sheet, but what that's telling us is that they're preparing a more normalised state, just in case there's something else-- another type of shock in the market. And I think that's more important to her right now than just trying to battle inflation. I would say that she needs justification for what she's doing.

So the fact that inflation's trajectory has not gone one direction, pushing inflation slightly to the side in the short term, helps her in her case for tighter monetary policy. But at the same time, I think she sees the situation as half full, where she has a very strong labour market, payrolls are significantly hire, job openings are at an all time high, unemployment's at a low. It's only a matter of time before the market that has rejected traditional economic theories, things like the Phillips curve, all of a sudden snap back into effect. And we start seeing a ratcheting up of inflation.

What are people in the market really interested in? I mean, would you say that this week really has been an obsessive, fear about the Fed? Or is it actually other central banks that the markets are really more focused on?

I mean, I think from a 10,000 feet view, the vantage point, we have to look at the primary driver for asset appreciation over the last 10 years. And it's hard not to look at a chart between the expansion of central bank balance sheets and say, the MSCI world index, and see them moving lock and step. And therefore, if we can loosely say that quantitative easing has helped asset prices significantly, we do also logically assume that the withdraw of that stimulus will have a counter effect.

So the question is, how quickly will that happen? And when will the market realise that now that with a Fed heading toward normalisation, with an ECB in that direction, with the BOE, the BOC, the Rick's Bank, the PBOC all shifting gears, with lone exception being the BOJ--

That's what I was going to say. They're resolutely all in for monetary easing, aren't they?

Agreed. How is that going to, and when will that, have the reverse effect on pricing?

And it feels like everybody's being as careful as possible, with the possible exception with the Canadians, who are really quite bullish about their interest rate drive. But everybody is really trying to get the market just comfortable about this idea that the easing is coming off.

Are central bank's good at being good at this? Are the policy makers workings through rhetoric-- I mean, it's all about rhetoric at the moment. Is that rhetoric tap really still on and working?

The communication story-- the central banks had the last 10 years to hone their craft. And they have become quite good. And I think a year ago or so we had this conversation about the SNB and their communication strategy shifting away from full transparent to a slightly closed door policy making strategy.

And just recently the SNB has also shifted from significantly overvalued to overvalued in their language. And it didn't cause a significant move in the Swiss Franc. So I think they've honed their craft. They've learned who their audience is. And they have become quite good at communicating and balancing what they need to do.

OK, so in effect you're painting a picture about the dollar isn't really going to move because a lot of the focus is on other central banks. But if the dollar is going to move, it's presumably going to be outside of Fed specific issues. It's the tax reform issue, particularly. Is that, do you think, the main driver of it, if it's going to happen-- the dollar up?

Right-- I mean, growth is already very strong. Labour markets is significantly strong. Exports are doing very well. I'm not sure that a tax reform or some other stimulus coming down the pipe, whether it's to $200 billion in hurricane relief, is going to make a huge impulse into the economy. It needs to be that inflation number.

So I would look more across the ocean to the ECB and what other central banks are doing because they have more room to catch up. Remember, the Fed has been tapering for almost two years now. They've been raising rates. So they're already well ahead of the game. It's more the ECB and the BOJ that are well behind the curve and have the most room to catch up.

So if we're going to see momentum for the rest of the year, I'll look out for that ECB meeting in October. After all, that's where the big moves have come in recent months, isn't it?

I think the onus is on the ECB. And it's their game to play. And they need to be very careful that the expectations for tighter policy in Europe doesn't trigger a significant move in the euro dollar. They're going to need to balance the language very carefully when they move forward.

And we should hear, in the next few days, a rash of central banks speakers. And I think the corporate line will be optimistic about the outlook for Europe, but concerned about political issues, as well as the direction for inflation, talking down the euro.

Just, finally, Peter, talking about talking down the euro and say, the Swiss and the Swiss Franc, and others, even the Canadians and the Canadian dollar, to what extent are they effectively needing to say that they're worried about currency appreciation without actually meaning it? Because if they didn't say anything, it might actually create greater appreciation.

Well, it goes back to what you were saying in terms of Yellen saying that inflation wasn't the primary motivator, or hinting that inflation wasn't the prime-- and even saying the fact that inflation wasn't higher was "a mystery." That's a very interesting and very human confession for a central banker to give us. So in terms of how much verbal intervention, specifically, on a currency a central banker should be allowed, or might put forward, I think the gloves are off.

I think the rules of communication are now open for a Draghi, whatever it takes. If things get too out of control in the euro, if the strength of the euro on a trade weighted basis starts, potentially, derailing growth in Europe, I don't think that Draghi will have a second thought about coming out swinging and going directly at the strength of the euro.

I look forward to watching that. My thanks to Peter Rosenstreich at Swissquote. Next week, we'll be digesting how European politics and economics might be reshaped, following Angela Merkel's expected coronation this weekend as chancellor for the fourth time in the German election. So join us again next week for Hard Currency. Until then, it's goodbye.