The US Federal Reserve is being forced to defend the dollar to prevent a breach of its post-war record low of Y100.40 and to counter a sharp fall against the German mark. On the face of it, this looks rather odd. The US economy is the fastest growing in the Group of Seven and US interest rates, after a five-year hiatus, have begun to rise.
There are, however, sound reasons for being bearish about the US currency. One is the Clinton administration's wholly unconvincing insistence that it does not want the dollar to weaken against the yen. No one believes it as long as the US/Japanese trade dispute goes unresolved. This is despite the fact that an appreciating yen further weakens the ailing Japanese economy and pushes the day of more balanced trade farther into the future.
Another factor is real interest rates - the difference between nominal rates and expectations over future inflation - which are moving against the dollar.
US interest rates have risen, true, but this has been accompanied by a sharp deterioration in expectations about US inflation, meaning that real US rates have hardly risen at all. In Germany, by contrast, there has been a sharp improvement in the outlook for real interest rates even though nominal rates are falling gently. This is because the country's inflation profile looks so much more promising.
The dollar's value against the yen continues to be undermined, meanwhile, by America's persistent trade deficit with Japan - a deficit that has been compounded by economic recovery in the US sucking in imports. On some measures the total US current account deficit could hit dollars 125bn to dollars 150bn this year - the highest since the last dollar crisis of the mid-1980s.
The inevitable result is a weaker dollar. At some point that weakness might become a flashpoint for more serious crisis, triggered perhaps by the US administration's campaign to undermine the inflation hawks at the Fed or by yet another breakdown in US-Japan trade relations. After a period of relative calm, currency markets may be about to return to the spotlight.Reuse content