We argue that the dollar is in its third significant rally since the end of Bretton Woods in 1971.The Reagan dollar rally was driven by the policy mix of tight monetary policy and loose fiscal policy.The G7 effort to stop the dollar’s appreciation at the Plaza Hotel in September 1985 marked the end of the Reagan dollar rally.
After a nearly ten-year bear market for the dollar, thatincluded the collapse of the Soviet Union, the fall of the Berlin Wall and the ERM crisis, there was a second dollar rally. The Clinton dollar rally was driven by the tech bubble. It too ended with G7 intervention (October 2000).
Both the Reagan and Clinton dollar rallies were preceded by rate hikes. This is not to say that all Fed hikes spur dollar rallies, but the two significant dollar rallies before the present were proceeded by the tightening of US monetary policy.The Clinton dollar rally also saw a fundamental change in the US approach to the dollar.
US Treasury officials, like Baker on the Republican side and Bentsen on the Democrat side, has threatened to devalue the dollar if a US trade partner, like Germany or Japan, did not acquiesce to US demands.Rubin’s appointment to head of the Treasury Department changed this.The strong dollar policy meant that the US would no longer use the dollar’s exchange rate as a lever to secure concessions.And indeed, since then, this has largely been the case.
In our analysis, the Obama dollar rally is being driven by the divergence between the US and most of the rest of the world. The US responded earlier and more aggressively to the end of the credit cycle than the eurozone or Japan. This is producing diverging economic outcomes a few years later.
One metric of this divergence is the premium the US government pays over Germany and Japan. That is what this Great Graphic, created on Bloomberg depicts. The white line is the US 2-year premium over Germany. Today it is reaching its best level in almost a decade (~145 bp).
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