US Dollar May Bloom on FOMC Outlook, Corporate Earnings

Today’s FOMC meeting will focus on its outlook for monetary policy. The central bank is moving away from a reliance on the “Keynesian” view of supply and demand in setting interest rates. The inflation target is also becoming less important.

Monetary policy has become a lot more flexible under the new FOMC. It is no longer under the control of the Chair, Janet Yellen, but of a committee of seven people.

Of course, you might think that money market funds will play a role in determining interest rates. However, that does not mean they are powerless – you need to get your own return and interest rate fluctuations must be accommodated.

The only way corporate earnings can rise is if they are rising more rapidly than the economy. Those who predict that the FOMC will go into reverse in the coming months or years should be careful what they wish for.

Janet Yellen does not appear to have much faith in those predictions as they stand. She is expecting the dollar to start blossoming in the coming months.

That’s because profit margins will increase, the number of jobs created will increase and the Federal Reserve will start using more of its balance sheet to cover the fiscal deficit. That, however, depends on whether or not the economy begins to grow faster. Of course, if the recovery is slow then profits will be affected.

Perhaps the Fed will finally come up with the right policy direction after all, and as a result there will be a higher yield spread between the yield on long US Treasury bonds and the yield on short US Treasuries. The yield spread is also one reason why yields are very low, and why so many long-term US bonds are yielding less than they once did.

Cost of capital is another important factor to watch. There is no reason that investment returns should not grow at a much faster rate than the rate of inflation. But that can only happen if the company is profitable.

However, the tax code is very complex and it could be hit by an IRS tax audit at any time. Then, there are always the issues with government contracts and property. The money and credit markets can move in either direction in a hurry, and unless the policy is smart enough to adapt to the current conditions it could suffer big losses.

On the other hand, perhaps the Federal Reserve’s latest move to make its policy decisions not subject to public scrutiny can be the spark that propels the US dollar to blossom. Before that happens, the US will be moving away from being the world’s reserve currency and to being a “net importer”. If the Fed thinks that will lead to a real US export boom, they might get their way.

Once the US dollar blooms in a positive direction and begins to appreciate, the world will have to scramble to get their exports to the US. Just as in the 1920s, many countries will have to import US goods and services to avoid going bankrupt.