Beyond the relative performance of the US economy against other major economies – although it’s a reflection of that performance – there are sizeable differentials between the yields available on US bonds and the minuscule-to-negative yields available in Europe or Japan. That’s despite three Fed rate cuts. Yields are lower in other economies because their economies are weaker than the US economy. The Fed’s rate cuts have weakened the dollar slightly in recent months against a basket of its major trading partners’ currencies, but it is still about 10 per cent higher against them than it was at the start of 2018. The dollar’s strength also has a structural element to it.

The US might account for only 10 per cent of the world’s trade and 15 per cent of the global economy but about a third of countries peg their currency to the dollar to some degree, 50 per cent of global trade is invoiced in US dollars, more than 60 per cent of the world’s foreign exchange reserves are denominated in US dollars and two-thirds of global security issuance is in US dollars. That means there is a very significant demand for the greenback outside the US. It is the world’s reserve currency and America’s deep and liquid markets are the world’s safe havens in times of risk or volatility. While that does create US dollar strength, it also allows Americans to live beyond their means and enables the US to have lower interest rates for government, business and households than would otherwise be the case for an economy with its spiralling debt and deficits. It’s also been a key element of America’s post-war geopolitical dominance. Its reserve currency status has enabled the US to use the dollar to impose punishing sanctions on countries and individuals. The US uses the dominance of its currency as a weapon. Thus, if Trump’s wishes were to come true, the US would be giving up a lot in exchange for a modest increase in competitiveness for its exporters and in protection for its domestic industries.

It is, however, unlikely that he will get his way regardless of whether he can eventually coerce the Fed to lower US rates beyond the point it believes is necessary to sustain US economic growth. The relationship between the Australian and US dollar highlights the way economic fundamentals drive the monetary policies of credible central banks and in turn the relative value of their currencies. Credit:Michel Bunn The Australian dollar floats as freely as any currency in the globe and therefore provides a reasonable benchmark against which to consider what might happen if the Fed bent to Trump’s will – or he convinced the US Treasury to intervene more directly to manipulate the value of the US dollar. Like the Fed, the Reserve Bank has lowered the Australian cash rate three times this year. It now sits at 0.75 per cent against the Fed’s target range of 2 to 2.25 per cent. The RBA’s first 25 basis point rate cut this year was in early June, followed by similar reductions in July and October. The Fed cut US rates for the first time in this cycle in July, with further cuts of 25 basis points each in September and October.

Loading While the rate reductions might have been similar, from early June to today the Australian dollar has weakened by about 2 per cent against the US dollar. The RBA minutes released this week indicated the bank gave serious consideration to a fourth cut. Had it done so, it is reasonable to assume the Australian dollar would have weakened further. The AUD:USD relationship highlights the way economic fundamentals drive the monetary policies of credible central banks and in turn the relative value of their currencies. The RBA doesn’t intervene to manipulate the value of the dollar nor directly target the currency with its rate decisions. If the Fed were to lower US rates for economically strategic reasons it would adversely affect other economies, which would lower their rates or, if their policy rates were at zero or below – as is the case in Europe and Japan – be forced deeper into unconventional monetary policy territory. Their currencies would inevitably depreciate against the US dollar.