- As the U.S. Federal Reserve pursues its most aggressive pace of tightening in decades, raising rates at 75-basis-points a pop and sending the dollar to its highest level simultaneously, the rest of the world is reeling at the cost of a stronger greenback.
- Until there’s greater clarity on the outlook, the dollar will likely continue to move from strength to strength until maximum pain, when other central bankers will lobby Washington for some for of relief.
American privilege can be defined as being self sufficient in all of the raw materials necessary for modern life and enjoying the luxury to import anything else needed using one’s own local currency, not so for the rest of the world.
As the U.S. Federal Reserve pursues its most aggressive pace of tightening in decades, raising rates at 75-basis-points a pop and sending the dollar to its highest level simultaneously, the rest of the world is reeling at the cost of a stronger greenback.
From the Brussels to Beijing, Tokyo to Ottawa, central banks globally are adopting a variety of tactics to deal with their rapidly declining currencies, with some doing everything possible to shore up their currencies, and others pursuing a divergent policy path from the Fed.
There are few parallels in modern history where the dollar, the lifeblood of global trade and the preferred reserve currency of the world has risen so much, so fast, leaving a trail of devastation in its wake.
The chaos in Sri Lanka is just one very visible manifestation of the dollar’s strength, with soaring food import costs and dollar-denominated debt default toppling a government and sparking civil unrest, and Sri Lanka may just be the tip of the iceberg.
By some measures, the dollar has already surpassed its all-time-high and it’s up 15% against a basket of currencies since mid-2021.
But with the Fed determined to take down inflation, there’s little to suggest that the dollar will start to retrace back to its previous levels.
The eurozone is bogged down by a war in its own backyard and Russia threatening to send the continent into a deep freeze this winter,
Japan is determined to keep rates at rock-bottom while the Swiss central bank has already raised borrowing costs for the first time in years, just to keep things on an even keel.
China can’t afford to tighten monetary policy now either as it’s reeling from a real estate market that threatens to implode its entire economy and Southeast Asia is still nursing wounds from the pandemic’s hit to tourism dollars and access to hard currency.
Demand for the dollar is also being fueled by investors looking for a safe haven and as markets prove more volatile, demand for the greenback rises.
In a low interest rate environment, U.S. Treasuries were shunned for risk, but now that borrowing costs are on the march again, these securities are in high demand, seen as one of the safest ways to store money.
But it’s not just the rest of the world that smarts from a soaring dollar – America’s largest exporters do as well, as evidenced by the greenback’s strength hammering the profits of some of America’s biggest companies, including IBM and Microsoft.
A broad economic slowdown, clarity on when the Fed will pivot to stop hiking rates, or a significant revival in China’s economic fortunes could hold the dollar back, but it’s not clear when these events will occur.
Until there’s greater clarity on the outlook, the dollar will likely continue to move from strength to strength until maximum pain, when other central bankers will lobby Washington for some for of relief.