Fed’s effort to increase reserves could drag on dollar
When the Federal Reserve cut interest rates for the second time in 11 years last week, many strategists viewed the move as a boost for the US dollar.A currency that yields less is normally expected to depreciate. But while the Fed leaned in the same dovish direction as other big central banks, it did so with less conviction than peers such as the European Central Bank and the Bank of Japan. Without a more emphatic shift towards more aggressive monetary easing measures from the US central bank, the dollar is likely to remain “persistently strong,” according to Lee Hardman, a currency analyst at MUFG in London.But for Hans Redeker at Morgan Stanley, there is another factor at work that could drag down the dollar, over time.It revolves around the amount of excess reserves held by commercial banks at the Fed. This became a critical matter last week when short-term US lending markets jammed up, sending the cost of borrowing cash overnight to historic highs.To alleviate the funding squeeze, the New York Fed repeatedly intervened in US money markets and on Friday announced a series of longer-term measures designed to ease congestion over critical periods such as the end of September, when banks tend to try to shrink their balance sheets to qualify for gentler regulatory treatment.Measures such as this are likely to weigh on the dollar, according to Mr Redeker, given that the dollar’s value tends to track closely the amount of excess reserves in the system. The more excess reserves available, he says, the higher the supply of dollars — and the lower the valuation of the greenback.