The bets are in. Money market traders believe that the Federal Reserve will launch a round of sizable purchases of Treasury securities next month, while could total some $500 billion over the next six months. In response, the dollar has moved lower, while various commodity prices, including gold, have soared.
The Federal Reserve wants to give some spark to the economy as it fights the possible risk of deflation, but some of the side effects may not be welcome. Efforts at reflation might turn out to be too successful. Already various firms are testing the water to see if they can boost prices, even modestly, to offset some of the rise in food, metals, and other commodity costs. Achieving the right formula—inflation not too hot but not too cold—could be difficult.
Meanwhile, the dollar has turned south, reaching a six-month low vis-à-vis the euro. With the Bank of England and the Bank of Japan likely to join the U.S. in “quantitative easing” (purchasing government securities and expanding their balance sheets) to drive long-term interest rates even lower, money is flowing to Europe and to stronger economies, such as those of Australia. The European Central Bank is resisting another round of easing with its typically more conservative and anti-inflationary stance, while Australia is already raising interest rates on economic strength driven by demand from China.
Other countries with stronger economies are also experiencing large inflows of funds and upward pressure on their currencies. This displeases many national leaders, such as those in Brazil, because of the potential damage to their export sectors. All countries cannot devalue and any competition to drive currency values downward will only benefit commodities.
The U.S. Federal Reserve is not explicitly attempting to push the greenback lower but results, not intentions, are what count.