President Donald Trump has never hesitated to criticize the U.S. Federal Reserve and the chairman he appointed, Jerome Powell, for, in Trump’s view, tightening monetary policy too aggressively. Now, European Central Bank President Mario Draghi’s is on Trump’s bad side for signaling that more monetary stimulus might soon be on the way in the eurozone.
Trump’s hostile response on Twitter to Draghi’s signal that the ECB could move to loosen the spigots as early as next month is stoking fears that a potential U.S. trade war with its major trading partners could also be accompanied by a currency war, as policy makers work to cheapen their currencies in what’s often is described as a race to the bottom in an effort to enhance the appeal of their wares to foreign buyers.
Draghi, speaking at a central-banking forum in Portugal, sent the euro
EURUSD, +0.0000%
tumbling early Tuesday and gave global equity markets a lift after making clear that the ECB was prepared to cut interest rates and could restart the bond buying program at the heart of its quantitative easing effort if needed to support the eurozone economy.
Trump soon complained, tweeting that Draghi’s remarks “immediately dropped the Euro against the Dollar, making it easier for them to compete against the USA. They have been getting away with this for years, along with China and others.”
Read: Trump says ECB’s Draghi is depressing euro to benefit trade
Later, in a panel discussion, Draghi was asked to respond to Trump’s criticism.
“Our mandate is price stability…I just said a moment ago that we are ready to use all the instruments that are necessary to fulfil this mandate. And we don’t target the exchange rate,” Draghi said. The annual inflation rate in the euro zone has remained stubbornly below the ECB’s medium-term target of near but just below 2%.
The euro was off 0.2% at $1.1195 versus the U.S. dollar in recent action, after sinking to a two-week low at $1.1181. The ICE U.S. Dollar Index
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, a measure of the currency against a basket of six major rivals, was up 0.1% at 97.657. The index is up 1.5% so far this year and off 0.1% in June.
Analysts credited the initial Draghi comments for buoying global equities, with stocks adding to their advance after a subsequent, unrelated Trump tweet hailing plans for an “extended meeting” with President Xi Jinping of China at the Group of 20 meeting in Japan later this month.
Stocks were lifted, with the pan-European Stoxx 600 Europe index
SXXP, +1.67%
ending with a gain of 1.7%. The S&P 500
SPX, +0.97%
rose 1.1% and the Dow Jones Industrial Average
DJIA, +1.35%
was up 374 points, or 1.4%, in mid-afternoon action.
Trump has long complained about the strength of the U.S. dollar and had hit out at the euro just last week, saying, via Twitter, that it and other currencies were “devalued against the dollar, putting the U.S. at a big disadvantage,” while also taking another swipe at the Fed.
Read: Why Trump’s tweets about the U.S. dollar might soon pack a lot more punch
Is the dollar overvalued against the euro? According to a number of purchasing power parity models, the answer is yes, said Jane Foley, senior FX strategist at Rabobank, in a note. But that isn’t difficult to explain, she said, in light of the nine interest rate increases implemented by the Fed between late 2015 and 2018. The rise in U.S. interest rates relative to the eurozone, and other economies, made the dollar more attractive. And in partial defense of the Fed, the Trump administration’s tax cuts briefly accelerated the U.S. expansion, putting pressure on the Fed to normalize rates more quickly (see chart below).
Rabobank
Meanwhile, subdued global inflation pressures are potentially setting the stage for a currency conflict.
“Any economy that is suffering from a prolonged bout of undesirably low inflation is likely to favor a weak currency. If several economies find themselves in the same boat coincidentally, the prerequisite conditions for a currency war are set,” Foley said.
Fed watchers argued that U.S. monetary-policy makers would be taking much of a cue from the ECB or any other central bank.
See: Despite dollar pressure, Draghi won’t spur Fed rate cut, economists say
And even with the Fed moving to easing mode, Foley said she was skeptical that would halt dollar strength versus other major currencies.
That’s because other global central banks besides the ECB are also leaning back toward easier policy. Meanwhile, the dollar’s haven status, thanks to the liquidity of the greenback and the credibility of the U.S. government and legal system, means that much of the money flowing out of high-risk assets ended up in the dollar, she said.
“We see risk that EUR/USD could dip further during the summer before [moving] higher in 2020 as the Fed’s rate-cutting cycle progresses,” she said.