IMF Chief Talking Up the Dollar

In an interview published in today’s Financial Times, soon-to-retire IMF managing director Rodrigo Rato declares the dollar to be undervalued.

Now we have noted that some technically minded traders see the dollar as oversold at current levels. But “oversold” is not the same thing as “undervalued.” Oversold suggests that there will be a near-term rebound, with the real possibility of the downward trend reasserting itself later. Undervalued, by contrast, means the currency is mispriced based on its fundamentals. Further note that currencies often trade away from their “fair” value and seem able to sustain those mispricings far longer than stocks or bonds generally do.

But why is Rato’s comment noteworthy? It isn’t merely that it is at odds with the widespread perception that the dollar is likely to remain in the neighborhood or below current values for some time to come; it also differs from the IMF’s findings of a mere two months ago.

On August 1, the IMF published a 54 page report that deemed the dollar to be 10% to 30% overvalued. Yes, the dollar has declined since then, but not more than the 10% to 30% range suggested. And the rise in long term inflation expectations indicated by the increase in ten year Treasury bond yields, would call for a cheaper rather than higher fundamental value for the dollar. In other words, the currency hasn’t moved enough to shift the earlier assessment, nor have its fundamentals changed favorably to a significant degree either.

Admittedly, Rato was somewhat cagey, since he said that dollar was overvalued using many measures that the IMF relies upon. “Many” may not constitute a majority. But his statement raises interesting questions. Is he trying to talk up the dollar, irrespective of its fundamentals? The ECB did not raise interest rates as expected earlier, and while the stated reasons had mainly to do with the perception of economic risk, an unstated but important consideration was not tanking the dollar. Using the power of the pulpit to support the dollar is a low cost move and could buy some key actors a little more freedom of action. Or, given the objections made by the US to the August 1 report, Rato could be using the intervening currency moves as a smokescreen to distance the IMF from the report while still suggesting, as he does in the interview, that China should let the yuan float irrespective of the value of the dollar.

And while the FT believes that Rato’s seeming unusual candor is due to his imminent departure, one has to wonder if his statement is sanctioned and Rato and his minders are playing the press skillfully.

From the Financial Times:

Managing directors of the International Monetary Fund are traditionally circumspect when talking about currency values. But with only a few weeks left in the job, Rodrigo Rato is unusually forthright.

“Right now the dollar is undervalued” on many measures used by the IMF to evaluate currencies, he says, though he adds that it was “certainly overvalued a few years ago”….

Mr Rato – who hands over the leadership of the IMF to Dominique Strauss-Kahn at the end of this month – says these financial and economic developments create a “new scenario for global imbalances” that policymakers need to “keep an eye on”.

He warns against excess volatility in currency markets – a standard IMF mantra, but one that takes on added significance in times like these. “Sudden movements in the currency markets are not what we need.”

Mr Rato clearly regards concern over the dollar-euro exchange rate as only part of a more complex global story. This also involves currencies such as China’s renminbi that are formally or informally tied to the dollar and therefore fall when it falls.

He says that, “independent of the value of the dollar”, it would be “in the interest of China” to adopt a more flexible exchange rate to help it manage its domestic economy and that this case is “becoming stronger”.

More currency flexibility from China would also help its neighbours, he says. Many emerging economies, particularly in Asia, are afraid to allow their currencies to appreciate against the dollar for fear of losing competitive advantage to China.

The outgoing IMF chief also hints at unease about Japan’s yen, which remains weak in part because of ultra-low interest rates. “Normalisation of monetary policy in Japan is an important medium-term objective.”….

That said, Mr Rato believes there are plenty of questions that do need to be addressed. These include “transparency questions” relating to banks’ exposure to off-balance-sheet vehicles, “methodology questions” regarding ratings agencies and incentives in credit markets, and questions over the structure of “regulatory systems”.

He says it is a “fact” that hedge funds have generally come through the crisis well so far and that incidents of hedge fund distress have not caused systemic strains. But this should not preclude further consideration of hedge funds by international policymakers.

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