Intervention: Huff, Puff, And Bluff

Economists, strategists, and reporters continue to have a difficult time getting a handle on the disruptive American President. They insist on taking seriously every feint of a person who appears to relish keeping his friends and adversaries off-balance. The one that continues to fuel a discussion that is generating more heat than light. Previously, Trump accused one or another country of currency manipulation. Yet, his own Treasury Department, which has softened the criteria, has not cited a single country, though a watchlist has been expanded.

It was the presidential tweets on July 3 that sparked the controversy. Trump repeated his accusation that China and Europe were manipulating their currencies to America's disadvantage, but added a threat of sorts: "We should MATCH them or continue being the dummies who sit back and politely watch as other countries continue to play their games." Many took it as a threat to intervene in the foreign exchange market to drive the dollar down, though, in fairness, it fits very well in his campaign to get the Fed to cut rates, as well. In fact, the ECB did not materially intervene in the foreign exchange market, and by all reckoning, the action by the PBOC was to slow its descent, to "match" them could be very well in interest rates than in material intervention.  

The conventional wisdom that emerged among analysts was that the near-term probability of intervention was small, it was increasing.  Balderdash. What is the evidence that the risks are increasing? Participants did not sell the dollar or demand a greater risk (volatility) premium. The US dollar has risen against the major currencies but the dollar-bloc this month. Three-month implied volatility is just above five-year lows, and a week after the controversial tweets that riled the analysts, 12-month volatility was at its lowest level in a dozen years.  

If it was a threat to intervene in the foreign exchange market, why would the threat become more potent over time? That begs the question, does the threat make it more likely objectively, or is that really just analysts' short-hand that they had not considered that scenario previously? Now they will have to think out it more than in the past, and therefore it is a more important risk in their informal models.  

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Read more by Marc on his site Marc to Market.

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