BNP Paribas AM: The Federal Reserve’s dollar dilemma


It would be an understatement to say that the Trump administration has presented challenges for the Federal Reserve: with the economy operating at around full employment, the government has introduced the sort of fiscal stimulus typically seen in recessions.

Dealing with fiscal stimulus and policy criticism…

The Fed has largely accommodated this fiscal stimulus, thereby allowing for above-trend GDP growth and below-trend unemployment rate for many years to come. This leaves policymakers with a significant challenge over the medium term – how to cool off the labour market gradually without engendering a persistent inflation overshoot or, conversely, throwing the economy into a recession.

There is another challenge: potential political interference in the setting of monetary policy. President Trump has on a number of occasions expressed his displeasure with policy tightening.

It looks likely that the Fed will continue to set what it believes to be appropriate policy without regard for any pressure or criticism from the administration, taking the longer-term perspective.

…and the potential threat of currency intervention

Still, it is not inconceivable that the administration could attempt to counteract interest-rate policy rate through the one monetary tool at its disposal, namely, foreign exchange intervention.

President Trump has already shown frustration with what he views as currency manipulation by other major economies and with a stronger US dollar that he views as hurting exports. At the very least, the President’s preferred style of negotiating suggests that the threat of large-scale intervention could be used in private discussions with Chairman Powell to pressure the Fed to pause its rate-rising cycle.

Read BNP Paribas Asset Management’s analysis and expectations what the Fed is likely to do in the “central bank watch” section on the Investors’ Corner blog.