Fed Mum This Time on the Dollar

June 25, 2008

In his Chatham speech earlier this month, Chairman Bernanke took the extraordinary step of digressing to comment about the dollar and warn about the association of depreciation and internal inflation.  Several other verbal salvos in defense of the U.S. currency followed.  But the dollar is nowhere to be found in the FOMC statement released earlier this hour.  To me, that omission indicates an unwillingness both to raise rates very soon and to tie future credit policy more closely to the dollar.  Better to leave things vague on this score than to cry wolf too often.  In a separate way, the FOMC moved considerably toward a possible change of direction, asserting both that downside growth risks “appear to have diminished somewhat” and that upside risks both to “inflation and expected inflation have increased.”  Normally, one would expect those juxtaposed thoughts to have lifted the dollar, but in the context of what Bernanke threw on the discussion table at Chatham, the lack of a follow-through comment about foreign exchange perhaps encouraged the currency to lose ground immediately after the statement’s release.  A greater worry to Fed officials should be that oil prices, which had dived sharply earlier today in response to higher U.S. oil inventories, trimmed some of those losses right after the FOMC statement was published.  Oil speculators clearly associate dollar weakness with higher energy prices.  Even if one does not subscribe to an inverse correlation between the dollar and inflation when growth is below trend, few would deny that a continuing rise in energy costs could ratchet inflation expectations and then actual inflation higher.  I expect minutes of this month’s meeting to have something to say about the dollar, and the issue is also likely to surface during next month’s semi-annual testimony by the Chairman before Congress.



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