The US dollar is trading strongly but its recent success is not good news for some. Sky’s business presenter Ian King takes a look at why.
These are heady times for the US dollar.
The de facto global reserve currency is currently trading at a two-decade high against the Japanese yen, a five-year high against the euro, and at its highest level against the pound since September 2020.
There are several reasons for the dollar’s recent turbo-charged performance.
The first and most obvious is that the outlook for US interest rates has changed considerably in recent days. Jay Powell, the chairman of the Federal Reserve, indicated very clearly last week that the US central bank is likely to raise its policy rate from the current 0.25%-0.5% range to 0.75%-1% at its rate-setting meeting next week.
Then there are the circumstances of the individual currencies against which the dollar moves.
Bad news for emerging economies
A stronger dollar is also, in general, bad news for emerging economies when those countries have denominated much of their debt in dollars because it raises their debt servicing costs. Higher US interest rates are also themselves a headache for emerging markets because they tend to draw capital out of those economies and towards the US. In this regard, the key currencies to watch are those of the so-called ‘fragile five’ – Brazil, India, Indonesia, South Africa, and Turkey – which are particularly reliant on a stable US economy.
Today’s news that the US economy contracted at an annualised rate of 1.4% during the first three months of the year, its first such contraction since the April-June quarter in 2020, may take some of the heat out of the dollar.
But the US economy is still very strong and the figures today reflect, as much as anything, merely a slowdown from the very strong pace of growth posted during the final three months of 2021.
And with the eurozone at risk of recession, the UK facing a slowdown and the Bank of Japan seemingly determined to run ultra-loose monetary policy, the dollar may not be ready to come back down to earth just yet.
30 Apr 2022 12:40AM (Updated: 30 Apr 2022 03:37AM)
LONDON : The dollar’s race to two-decade highs is leaving a trail of destruction in its wake, exacerbating inflation in other countries and tightening financial conditions just as the world economy confronts the prospect of a slowdown in growth.
This year’s 8 per cent gain against a basket of currencies is driven partly by bets that the U.S. Federal Reserve will raise interest rates faster and further than other developed countries, and partly by its status as a safe haven in times of turbulence.
It is also supported by Japan’s reluctance to ditch its super-easy policies, and fears of recession in Europe.
Here are some areas affected by the dollar’s muscle-flexing:
Currency weakness normally benefits export-reliant Europe and Japan, but the equation may not hold when inflation is high and rising.
Euro zone inflation hit a record 7.5 per cent this month, although so far European Central Bank policymakers blame it mainly on energy prices.
Bank of Japan boss Haruhiko Kuroda still views yen weakness as a positive for Japan, but lawmakers fret that the yen, at 20-year lows, will inflict damage via costlier food and fuel. Half of Japanese firms expect higher costs to hurt earnings, a survey found.
2/ TIGHTENING BECOMING FRIGHTENING
A rising U.S. dollar tends to tighten financial conditions, which reflect the availability of funding. Goldman Sachs estimates that a 100 bps tightening in its widely used proprietary Financial Conditions Index (FCI) crimps growth by one percentage point in the following year.
“It has got to be concerning, given everything else that’s going on. This is just the time you don’t want too much tightening of conditions,” said Justin Onuekwusi, portfolio manager at Legal & General Investment Management.
3/ THE EMERGING PROBLEM
Almost all past emerging market crises were linked to dollar strength. A 10.5 per cent jump in 1993 followed by a 4.6 per cent rise in 1994 for instance were blamed for triggering the “Tequila crisis” in Mexico, which was followed by meltdowns in emerging markets in Asia, as well as Brazil and Russia.
Dollar strength means higher revenues in local currencies for commodity-exporting developing countries. But the flip side is higher debt servicing costs.
4/NO RELIEF ON COMMODITIES
The rule of thumb is that a firmer greenback makes dollar-denominated commodities costlier for consumers who use other currencies, eventually subduing demand and prices.
This year, however, tight supplies of major commodities have prevented that equation from kicking in as the Ukraine-Russia war has hit exports of oil, grain, metals and fertiliser, keeping prices elevated.
5/GOOD FOR FED?
The Fed might welcome a rising greenback that calms imported inflation – Societe Generale estimates a 10 per cent dollar appreciation causes U.S. consumer inflation to decline by 0.5 per centage points over a year.
If dollar gains continue, the Fed won’t need to tighten monetary policy as aggressively as anticipated; notably, the dollar surge of the past week has also seen money market bets on Fed rate hikes stabilise.