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Last week, in a subscriber INK blog posting we summarized the case made by Richmond Fed President Jeffrey Lacker for a June rate rise. His key assumption was that inflation was heading back to 2% which is widely viewed as the Fed's objective. Yesterday, we heard what amounted to a counter argument from newbie Federal Reserve Governor Lael Brainard. According to a Reuters article, the governor indicated that headwinds still confront the economy. Those headwinds include the recent rally in the U.S. dollar.
The Fed governor's comments are noteworthy because she is a permanent member of the Fed's Open Market Committee which decides the direction of monetary policy. Market participants often give more weight to comments from permanent members of the FOMC compared to regional Fed presidents such as Mr. Lacker who rotate annually on the Committee. In addition, Ms. Brainard hails from the Treasury where she was head of international economic matters. Given that the Treasury is responsible dollar policy, her dovish remarks would seem to suggest that Washington policy makers at both the Fed and the Administration are not so happy about America losing the race to the bottom in global currency wars.
Federal Reserve Governor Lael Brainard
Indeed, Canada, which is America's largest trading partner, has seen its loonie flounder badly at the hands of Bank of Canada Governor Stephen Poloz. The head of the Canadian central bank has been actively working to deflate Canadian global purchasing power ever since he took over two years ago (it seems longer than that). Under the Poloz regime, exporters have been the relative winners while consumers (most Canadians) and first time home buyers have been on the short end of the stick as both consumer price and housing price inflation have been strong.
It may be that recent gains by Canadian exporters have caught the attention of Washington policy makers. If that is the case, the bullish greenback trade may well have to reverse before the Fed raises rates. And if that happens, our deep cyclical theme remains intact. In fact, the only difference is that the deep cyclical game may just be starting. A falling U.S. dollar would eventually set the stage for Fed rate rises. While the Richmond Fed president appears ready to pull the trigger on boosting rates, he may have to wait for a U.S. dollar correction to unfold before his colleagues on the FOMC are ready to tighten.
In a contest between the Fed and the Bank of Canada to see who can "achieve" a lower domestic currency, we have little doubt who would win that battle.
An earlier version of this post was published this morning on INKResearch.com and the TD Direct Investing website.
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