Developed economies are taking a hit from dollar appreciation to multi-decade highs in ways once more familiar to their emerging-market peers.
The dollar is driven by the Federal Reserve’s most aggressive tightening cycle in more than a generation. A stronger dollar pushes rival currencies lower and raises the cost of imported goods. The dollar also tightened financial conditions and fueled inflation in other economies.
The global waves of the Fed’s tightening are not new. In the first episode in recent years, the serious strength of the dollar has been more noticeable. It had noticed against the currencies of developed nations as a group than against emerging economies.
“A stronger dollar usually comes with higher short- and long-term interest rates in the United States. Interest rates also depend on stress on global markets and a flight to the perceived safety of the dollar,” said Maurice Obstfeld. Maurice Obstfeld is a senior fellow at the Peterson Institute for International Economics. “Those tighter financial conditions are slowing developed economies around the world.”
The Fed’s trade-weighted dollar index against advanced economies has soared 10% this year to its most substantial level since 2002. The emerging market measure has risen a more modest 3.7% and remains well below its 2020 pandemic high.
“By raising policy rates, other countries are unlikely to stop the depreciation of their currencies,” said Sayuri Shirai. Sayuri Shirai is a former Bank of Japan board member who is now a professor at Keio University.
This is because “the strength of the dollar increased demand for U.S. fixed income assets. It reflects global recessionary risks from larger-than-expected policy rate increases around the world.” Spoke.
That conundrum will be illustrated in the coming day. The European Central Bank may consider a record rate hike of 75 basis points. As it grapples with record inflation and the euro is below parity with the dollar. The Bank of Canada is inclined to rise by the same amount. The Reserve Bank of Australia has offered another half-percentage-point rate increase.
In the UK, which is already in recession, according to a business lobby, the Bank of England could tighten further on Sept. 15. The Bank of England faces a loss of investor faith that has pushed the pound to the brink of its lowest level since 1985.
And the yen’s drop to a quarter-century low is making it difficult for BOJ Governor Haruhiko Kuroda to stick to his line. Massive monetary support is still needed, even in the face of rising prices.
The Fed is not done rising yet. The relief on the currency front for the world’s central bankers can only come once U.S. counterparts control consumer prices.
It became clear that the Fed would switch to Change mode about a year ago. The developed-market currencies have struggled at least as much as their emerging-nation counterparts. Across the top 31 exchange rates tracked by Bloomberg. Four developed rates were among the top 10 losers. The Canadian dollar was among the top 10 performers.
The ECB currency is the most traded with the dollar. The current energy crisis has provided their policymakers. The provision was a particularly sharp reminder of the euro’s role as an inflation channel. Especially due to the use of the dollar in the denomination of global commodity prices.
“I would say that, in this particular situation of an energy supply shock, the exchange rate matters more. ECB Executive Board member Isabel Schnabel told Reuters last month when asked about previous research suggesting that the pass-through to inflation has slowed.
Japan, whose currency is the second most traded with the dollar, is also feeling the brunt. Having surpassed the level of 143, the coin is not far from the 146 mark that prompted a joint action with the United States in 1998 to prop it up. It also increases the odds that inflation will exceed 3%, well above Kuroda’s 2% target.
While the BOJ chief insists that a recent supply-driven consumer price hike won’t last. The households and businesses are becoming restless as the yen plummets, turbocharging rising energy and import costs. Officials warn against excessive volatility.
“Sudden movements in the foreign exchange market are not desirable,” Japan’s Finance Minister Shunichi Suzuki told reporters after an online meeting of G-7 finance ministers. “Recent moves in the currency markets are a bit on the big side,” he said.
The biggest concern for many countries could be that local rate increases may do little to curb their currencies because their economies appear more fragile than those of the United States.
Sterling is poised to fall past its March 2020 low, even as swap traders set the price for the BOE to overtake the Fed, with bets showing the UK benchmark index topping 4.25% in six months, topping 4% in the US by then.
Some, such as Chile and India, have also stepped in to support their currencies. It is more difficult for their peers in developed nations.
One possibility of relief would be a slowdown in the U.S. economy. It will remove steam from the Fed’s tightening pace and, by extension, causes the dollar to weaken.
The size of the rate hike that Fed officials will opt for on Sept. 20-21 monetary policy meeting will likely be heavily influenced by the latest monthly reading on consumer prices, to be released on Sept. 13. For now, the Fed has signaled that relief may be a long way off, with the need to maintain the tight policy for some time to stifle inflation.
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