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.

About Scott Sumner 490 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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