FED WATCH: Dropping Dollar Doesn't Yet Merit Fed Concern
By MICHAEL S. DERBY
Of DOW JONES NEWSWIRES
NEW YORK -- The ongoing drubbing of the dollar would appear to stand scant chance of fueling the sort of inflationary pressures that would alter the Federal Reserve's current monetary stance.
Economist say the greenback would have to go a lot further if the Fed is to reevaluate its current predisposition toward raising interests rates slowly. Risks to the economic recovery continue to outweigh those of inflation, they say, even if a weaker dollar starts to produce signs of some so-called imported inflation.
To the extent dollar depreciation does become a problem for central bank policy makers, economists say, depends largely on the pace at which it proceeds. If the decline against its key counterparts remains relatively gradual, few see any reason for the Fed to raise rates sooner and more aggressively.
At issue for the Fed is the impact that a rise in import prices might have on the broader economy, along with the possibility that U.S. producers would respond to higher import prices with increases of their own.
"What we've seen so far is only a minimal reversal in the uptrend" in the dollar's value over the past several years, said Jim O'Sullivan, economist at UBS Warburg in Stamford, Conn. "We'd need to see a lot more weakness" in the dollar over a sustained period before the Fed will get concerned that inflation may be moving beyond their comfort level, he said.
If manufacturers were to begin lifting prices, they'd be doing so after a considerable stretch in which they'd been virtually unable to bump higher prices. That minimal inflation environment has been seen as instrumental in allowing the Fed to keep interest rates at 40-year lows, as the central bank has sought to get economic growth and job creation back on track.
Notably, the strength of the dollar over the past six years is often cited as one of a number of forces that helped keep inflation under control throughout that period - others include an improvement in productivity, as well as the fact that deregulation meant that producers were subject to greater competition from both overseas and local rivals across a range of industries.
But the dollar's decline is not generating the opposite response: There is little concern that those disinflationary benefits are being reversed, perhaps because the structural factors are still largely in place - for example, U.S. productivity grew at 8.4% in the first quarter, a 19-year record.
Not That Far...Yet
Economists say that from the Fed's point of view, the dollar's decline must be balanced against both how far it has come over the last few years and the magnitude of the slide of recent days. The dollar is now at 16-month lows against the euro, a six-month low versus the yen, and a seven-month nadir versus the pound.
"As long as it's an orderly decline and not a precipitous...decline, it should be somewhat of a welcome development" for the Fed, because of its effect in increasing the competitiveness of U.S. goods overseas, said Kathleen Stephansen, senior economist with Credit Suisse First Boston in New York.
A downturn in the currency had long been expected, and is being attributed to continued concern over the state of U.S. corporate profitability and the very hefty current account deficit. Additionally, some have noted that other large countries' economic prospects are looking brighter, which is diverting some investment flows from the United States.
Yet even with its broad-based weakness, economists note that on a trade-weighted basis the dollar has only fallen 3% from its peak in March this year. At that time, it was up 35% from its low in 1995.
O'Sullivan said a 10% decline in the dollar adds 0.5% to inflation in the subsequent year, and that a 5% trade-weighted decline over a year would add a quarter percent to next year's inflation.
Given the relative modesty of the current decline, then, many analysts argue that the Fed can continue to wait and continue to maintain low interest rates drives the U.S. economy toward an unambiguous recovery.
And when some reports, like the April consumer price index and the last two releases from the Institute for Supply Management, have shown robust price gains, its been tied largely toward a rebound in depressed energy prices, and not as a harbinger that prices are on the march higher.
Pricing Power
Still, a falling dollar does help give manufacturers more room than they've had in some time to raise prices, a development with positive and negative aspects for the U.S. economy.
The ISM's Norbert Ore, who directs the group's factory sector survey, said Monday that "manufacturers look to be getting back some pricing power... It was still the case in May that manufacturers are managing to hold on to the price increases they've put into effect."
And while that does mean that price pressures will likely rise above their current tepid levels, it would help many companies improve what is now a dismal state of profitability, the increased proceeds of which can be plied back into new business investment.
The improvement in pricing power comes because the dropping dollar makes U.S. exports cheaper overseas and thus easier to buy, while at the same time making foreign imports more expensive for domestic consumers. Blunting the impact of rising import prices on the broader economy is their relatively small size as a part of the overall economy, comprising just under 16% of total economic activity.
Still, as U.S.-made goods become cheaper relative to those produced in other countries, they'll be more heavily bought both by domestic and overseas consumers. That's a clear plus for U.S. growth, and would likely help extend the rebound that's already being seen in data that looks at the performance of the factory sector.
"The weakening of the dollar, if it were to continue" would make U.S. businesses more competitive "and would reinforce the improving outlook for the manufacturing sector," said Charles Lieberman, chief economists at the Advisors Financial Center in Suffern, N.Y.
-Michael S. Derby, Dow Jones Newswires; 201-938-4192; michael.derby@dowjones.com
Updated June 4, 2002 12:50 p.m. EDT |
