Why the soaring dollar raises questions—and doubts–about a Plaza Accord-style intervention

The combination of persistent inflation and sluggish growth around the world, along with a US central bank committed to aggressively raising rates, has made the greenback the most triumphant gainer in the financial market. The strong dollar crushes rival currencies in the process and wreaks havoc around the world. And because the Federal Reserve isn’t done with raising rates yet, the dollar — which moves in tandem with U.S. borrowing costs, relative to the rest of the world — has more room to maneuver.

The ICE US Dollar Index DXY,
-0.19%,
which measures the currency against a basket of six major rivals, has risen 23% in the past 12 months and is trading at its highest level since around April 2002, despite a 0.3% drop on Thursday that moderated earnings this week, according to Refinitiv. Its strong rise has caught almost everyone’s attention: more and more central banks, like Japan’s, are taking steps to bolster their own currencies. Meanwhile, an adviser to US President Joe Biden this week dismissed the idea of ​​a Plaza Accord-style intervention, as did a team at Morgan Stanley.

“Coordinated foreign exchange intervention is difficult in the modern era and we doubt it will happen anytime soon. If it did, we doubt under current conditions that it would lead to sustained dollar weakness,” according to a Thursday note from Morgan Stanley economists and strategists.

Last week’s historic intervention by Japan to support the yen for the first time in decades is the main reason why talks of a major intervention in the dollar have resumed, even if the question of whether it will ever happen is still unsettled. .

The Place Accord refers to the unprecedented, ambitious and far-reaching monetary intervention agreement reached by officials from the United States, Japan, West Germany, France and the United Kingdom who met at the Plaza Hotel in New York. The goal was to finish an unruly gathering in the value of the dollar against other major currencies during the first half of the 1980s. It worked, driving the greenback down through the next decade, but not without nations agreeing to adjust their own savings on a scale that seems almost unimaginable today.

“We forget that the discussions on currency coordination that led to the Plaza agreement arguably began in 1982, which would put the time frame for such an agreement to be more than three years old,” he wrote. Morgan Stanley team.

In addition, a weaker dollar would undermine the Federal Reserve’s goal of reducing inflation, the team of economists and strategists said, adding that “a weaker dollar is, ultimately, inflationary in the United States. United and deflationary abroad”. Even if intervention did take place, it would likely be on the back of more volatile moves in financial markets, they said.

For now, the crowd of so-called “dollar vigilantes” — or foreign central banks resisting a strong dollar — is growing as the dollar’s rise tightens global financial conditions due to volatility. currencies and rising dollar funding costs of emerging markets, according to Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York. In the process, he said, it creates “margin money kings,” with investors selling stocks and bonds.

The People’s Bank of China, which issued a statement Wednesday discouraging speculation about the falling yuan is just the latest example of “dollar vigilantes” to emerge, Emons said.

Like Morgan Stanley, Emons argued that formal dollar intervention is unlikely, although another form of action could replace it: that would be “increased central bank rhetoric on a strong dollar.”

As the dollar index fell on Thursday afternoon, Treasury yields climbed and the three major U.S. stock indices DJIA,
-2.19%

SPX,
-2.77%

COMP,
-3.69%
fell sharply as worries about Fed tightening returned to center stage.