The US Dollar Is Likely to Remain Strong, but That Won't Boost Productivity

New York (Oct 25)  The value of the U.S. dollar has increased over the past few months, generally because of what is happening elsewhere in the world, rather than anything that is happening in the U.S.  Of course, there was the British vote to leave the European Union. This has had a major impact on the value of the dollar.

One British pound cost about $1.48 just before the vote and $1.22 now.

The euro has fared better but still lost value. It required over $1.13 to purchase a euro just before the Brexit vote, and now the price is less than $1.09.

Amid the turmoil, the world seems to have taken advantage of the dollar's strong value. Money is flowing to the U.S. and away from the rest of the world.

For example, since April 1, a Federal Reserve index of the value of the dollar against major currencies has risen from less than 90 to more than 92, a good bounce. Against a wider number of currencies, the Fed's broad dollar index, the value of the dollar index has risen from less than 120 to more than 124.

A further indicator of the flows of money into the U.S. is the yield on U.S. Treasury Inflation Protected Securities, or TIPS. During the past seven years, roughly the length of the current economic recovery in the U.S., the yield on the five-year TIPS and the 10-year TIPS has dropped to zero or to less than zero as risk-averse investors have poured into the U.S. looking for a safe haven.

As those investors have kept their funds here, the yields on these TIPS have continued to remain in negative territory or near-negative territory.

In the latest round of money flows, the yield on the five-year TIPS dropped to less than zero in late February. The yield on the 10-year TIPS dropped to less than zero in early July.

These yields have remained at low levels, and now the yield on the five-year TIPS is around a negative 45 basis points, while the yield on the 10-year TIPS remains slightly above zero -- around 4 basis points last week.

This foreign money has flowed into the U.S. because of the value provided by the U.S. currency. The funds have remained here for an extended period of time.

Of course, the possibility that the Federal Reserve will raise short-term interest rates in December is also encouraging to the owners of these funds.

Over the past two years the dollar has rallied every time it was believed that the Federal Reserve would raise its policy rate.

When the Fed failed to raise its rate, the value of the dollar declined again.

It seems as if money managers would like the Fed to raise its policy rate and to help keep the value of the dollar strong.
It almost seemed as if the Fed raised its rate last December to show the world that it could raise its policy rate.

That may be the case again this year.

Source: TheStreet