Why the dollar rallied

There seems to be some confusion about yesterday’s rally in the dollar.  Here is Kate Mackenzie and FT.com/Alphaville:

As Sumner adds, the dollar rose along with short-term Treasury yields on the news.

Stock markets are also reflecting a big risk-off sentiment.

Of course, it’s debatable how much of this is due to the Twist launch itself, and how much to the mention of “significant downside risks to the economic outlook”, and how much just to the general despair that this type/scale of action will be adequate in the face of a looming slowdown and contractionary fiscal policy.

Each of those sentences is individual correct, but together they create a slightly misleading impression.  The falling stock prices could have been due to a forecast of downside risks, but fears of a weaker US economy would make the dollar fall.  The dollar rally was produced by tighter than expected money, just as in late 2008.  Here’s Pablo Gorondi of Associated Press:

“The dollar’s reaction to Operation Twist has been the opposite of what we would have predicted; the dollar looks stronger after it, which makes little sense,” said analysts at U.S. energy consultancy Cameron Hanover. “It seems to be telling us that investors had already discounted a larger quantitative easing program. That would go a long way toward explaining the resilience of oil prices over the last few months.”

That’s right, it wasn’t Operation Twist, which was priced in (but ineffective), it was the lack of even a hint of anything more, of a backup plan.  Bye bye Bernanke put.


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12 Responses to “Why the dollar rallied”

  1. Gravatar of Morgan Warstler Morgan Warstler
    22. September 2011 at 05:26

    “Bye bye Bernanke put.”

    Bernanke put = 2% CPI

    http://bpp.mit.edu/usa/

  2. Gravatar of RG RG
    22. September 2011 at 05:37

    I know nothign about nothing, but is there any chance the Fed is flattening the curve to incentivize refis and debt restructures BEFORE ramping up NGDP targeting (i.e. taking a multi pronged approach to cure the debt hangover)?

  3. Gravatar of K K
    22. September 2011 at 05:44

    Scott: “That’s right, it wasn’t Operation Twist, which was priced in (but ineffective)”

    No, *it wasn’t*! If it had been priced in the 30 yr wouldn’t have rallied 15 bps. The market didn’t think they would do it, because it’s stupid and wrong. The market wants more, not less, duration because it’s a great hedge for long market (equity) positions. The Fed needs to get out of treasuries and *fast*.

  4. Gravatar of Cthorm Cthorm
    22. September 2011 at 06:25

    @K, I don’t think treasuries had to literally be priced at current levels to say that Operation Twist was “priced in.” Operation Twist was expected and incorporated into the baseline scenario of the market, the scale was within the range being estimated (Bill Gross estimated 100-500 billion on CNBC just before the announcement). The maturities the Fed was going to target was at question, with most firms expecting 10 year treasuries. Scott is right on the money that the Fed conspicuously DID NOT signal other policy tools reserved for further weakness. In the eyes of the market, the Fed is effectively saying “the economy is significantly weakening and our policy response is going to be limited to a flatter yield curve and continued low interest rates” with no more signals of looser policy down the road.

  5. Gravatar of Secondary Sources: Danger Zone, Dollar Rally, Four Years Later – Real Time Economics – WSJ Secondary Sources: Danger Zone, Dollar Rally, Four Years Later - Real Time Economics - WSJ
    22. September 2011 at 06:27

    […] […]

  6. Gravatar of Scott Sumner Scott Sumner
    22. September 2011 at 07:01

    Morgan, The CPI is up 1% a year over the past three years.

    RG, Maybe, but debt isn’t the problem so it won’t help.

    K, You said;

    “No, *it wasn’t*! If it had been priced in the 30 yr wouldn’t have rallied 15 bps. The market didn’t think they would do it, because it’s stupid and wrong.”

    Maybe not fully price in, but that doesn’t change my argument. No one thinks the dollar soared and stocks plunged because the fed cut long rates by a surprising amount. The “news” was tighter than expected money, that’s clear. BTW, long bonds can also fall on slower expected NGDP growth, not just twist. In the past they’ve fallen sharply on bearish news. But I’ll grant you it may not have been fully priced in.

    Cthorm, I agree.

  7. Gravatar of RG RG
    22. September 2011 at 07:08

    How is debt not partially the problem? Governments across the world are awash in it. We can’t continuously grow our way out of it, so a partial debt deflation/restructuring followed by a partial inflation seems to be a solution.

  8. Gravatar of dWj dWj
    22. September 2011 at 09:58

    5 and 10 year TIPS are down (higher yield) while nominal bonds soar today.

  9. Gravatar of Meegs Meegs
    22. September 2011 at 11:37

    The Bernanke put is a lot lower than the market expected.

    If 3 FED members dissented on Operation Twist, then maybe Bernanke just didn’t have the votes for anything more.

    Also, why would Obama think “monetary stimulus had blown its wad” and ignore his own economists? Well, maybe from reading Krugman…

    Scott, I remember you criticizing Krugman’s posts about fiscal vs. monetary policy. If only Obama read your blog instead of Krugman’s.

  10. Gravatar of Meegs Meegs
    22. September 2011 at 11:38

    If Obama had read your blog instead of Krugman’s, then maybe Obama would have filled the FED vacancies sooner and we would have had the votes for the correct monetary policy.

  11. Gravatar of Broken Records and Strong Dollar Policies | :: progenies of a dark apocalypse :: Broken Records and Strong Dollar Policies | :: progenies of a dark apocalypse ::
    22. September 2011 at 15:51

    […] of fact, “the dollar rally was produced by tighter than expected money, just as in late 2008 (Scott Sumner).” The reason the dollar has fallen since its peak in 2009 was because of fears of a weak US […]

  12. Gravatar of Scott Sumner Scott Sumner
    22. September 2011 at 16:18

    RG, Better monetary policy plus reasonable fiscal reforms would fix many of the problems–Greece is a hopeless case.

    I agree debt is a big problem, I just meant it’s not what’s causing the recession.

    dwj, You mean the yields are down, right?

    Meegs, Fair point.

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