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A little more than a month after the initial move, it is still not clear the extent to which China is truly allowing market forces to drive the currency. However, it is clear that Chinese officials do not embrace market forces as a force of nature like so many Westerners. Rather China tries to shape market forces through regulatory/liberalization efforts, such as presently trying to encourage capital inflows.

Bank of England's Financial Policy Committee:

The meeting is unlikely to impact sterling or the UK debt market. However, unlike the Federal Reserve which seems distraught over the turbulence in China, the Bank of England seems less perturbed. This contrast does not mean the Bank of England is more likely to hike interest rates before the Federal Reserve. This is not to imply that the BOE is waiting on the Fed to act first, to test the waters, so to speak. It is that they are responding to essentially the same macroeconomic considerations, like low inflation and weak global demand.

On one hand, the UK appears to be experiencing greater wage pressure than is evident in the US. On the other hand, the UK economy is also more sensitive to an increase in interest rates than the US. The highly development mortgage market in the US means that most homeowners have locked in low interest rates, which are not sensitive to a rise in interest rates. Homeowners in the UK typically have variable rate mortgages that respond quickly to increases in the base rate. 

The Dollar:

From an economic rather than an investment point of view, the Fed's real broad trade-weighted index is the most important measure of the dollar. In August, it made a new cyclical high of 97.30. It finished last year near 90.55. It is up almost 21% from the July 2011 record lows. If this dollar rally matches the magnitude of the Clinton dollar rally (34%), the real broad trade-weighted index will rise toward 107. If the Obama dollar rally, driven by an extended divergence of monetary policy, is the average of the Reagan and Clinton dollar rallies (the other two dollar rallies since the end of Bretton Woods), the real broad trade-weighted index will rise toward 115.5.

The dollar does not appear to be making much headway this month.  In fact, September could be only the third month this year (so far) that the real broad trade-index has not risen. Thus far this month, the dollar has fallen in nominal terms against its major trading partners save the Canadian dollar, against which it has risen about 0.6%. Through September 18, the yen has risen 1.0% against the dollar, the euro is up 0.8%, the Mexican peso is up 0.6%, and the Chinese yuan is up about 0.25%.

Marc Chandler
Global head of currency strategy at BBH
Marc to Market

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