Strong US dollar

What the Strong US dollar has to do with the Global Economy?

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In 2022, the value of the U.S. dollar has grown an impressive 14% compared to major currencies, reaching its highest level since the early 2000s. The dollar continues to surge despite recession fears and signs of a slowing economy. For the first time in two decades, the strong US dollar, on a steady upward trend for a year now, has exceeded the ‘Euro’. Likewise, the Japanese ‘Yen’ is also dropped significantly against the strong US dollar. According to many financial experts, the strong US dollar isn’t likely to ease off anytime soon! 

What does it mean to say that the US dollar is stronger?

A strong US dollar means that it is possible to purchase more foreign currencies with it than it ever was before. Let’s take the Japanese yen as an example. One year ago, $1 would get you about 110 yen. But now it can buy you about 143. The strong US dollar has moved about 30% more against another currency, making it one of its biggest moves ever. 

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Keeping in mind the fact that banks, businesses, and traders are constantly buying and selling foreign currencies across time zones around the world, the value of a foreign currency and its exchange rates are constantly fluctuating. 

Since the beginning of this year, the US Dollar Index, which compares the dollar against the euro, yen and other major currencies, has risen by more than 14%. When compared with other investments that have experienced a dismal year, this gain seems even more impressive. The U.S. stock market is down more than 19%, bitcoin has more than halved, and gold has declined more than 7%.

Why is the US dollar extremely strong right now?

Despite things being weird in the US economy at the moment, the dollar has become a better investment for investors than most other currencies because of a combination of factors. 

Kenneth Rogoff, a Harvard University economist and former chief economist at the International Monetary Fund, said the Federal Reserve is on track to raise interest rates faster than other major countries. In March, the central bank started raising interest rates after keeping them near zero during the pandemic, and it has now raised rates three-quarters of a percentage point. A higher interest rate makes the dollar more attractive to investors since they would be able to earn a higher return on their investment. 

According to Rogoff, the US economy looks healthier as a result of Russia's invasion of Ukraine and skyrocketing natural gas prices. “While everyone is talking about the recession, the US economy does much better than many other economies,” he added. 

UBS investment banker Vassili Serebriakov said that the dollar acts as a “safe haven.” As investors grow more concerned about the world economy, they flock to the strong US dollar, putting their money in safer assets like US Treasury bonds. As a result, the value of the currency has increased. Serebriakov explained that the recent downturn has less to do with the US and more to do with the global economy.

What does the strong US dollar mean to Americans?

A stronger dollar can help curb inflation by making imports cheaper. If the dollar becomes more valuable, foreign sellers are more likely to lower their prices, which results in lower prices for imported products that Americans buy. A strong US dollar is also expected to reduce overall inflation by 0.2 or 0.3%, compared with a 9.1% rise in consumer prices last year. 

Other positive signs can also be found. Generally speaking, a stronger dollar makes travelling abroad more affordable for Americans. Purchasing luxury goods and fine wines abroad has already become easier for Americans. The weaker euro also makes it cheaper for American buyers to buy real estate in Europe than a year ago, so some are househunting in countries like France. 

Despite a strong US dollar being generally favourable for American consumers, companies that operate abroad may be adversely affected by it primarily because revenues and profits earned in local currencies lose value in dollar terms, reducing demand overseas.

Strong US dollar threatens Europe

It is almost certain that the Fed is making the hardships in Europe worse by raising interest rates. As interest rates rise, it becomes more expensive for people to borrow money, making the strong US dollar more valuable compared to other currencies. In the past year, the Euro has fallen about 12% against the dollar, reaching one-to-one, its weakest level since about 20 years ago. On the other hand, the British pound has fallen more than 15% since the mid-1980s.

What the Strong US dollar has to do with the Global Economy?
Source: FactSet

A comparison of the Japanese yen to the dollar shows a 20% drop, a 9% drop in the Chinese renminbi, a 7% decline in the Indian rupee and a 5% decline in the Swiss franc. It is important to understand that the changing values of currencies influence the real world in various ways. 

In times of low-interest rates in the U.S., global investors have a tendency to invest in emerging markets, or economies that are transitioning from a developing economy to a developed economy. In contrast, when the interest rates in the United States start increasing and the value of the US dollar goes up, money begins to flow out of those countries at a faster pace. 

As the dollar rises and their currencies depreciate, it becomes harder to make repayments for countries that borrow heavily in dollars, resulting in a greater need for dollars. 

What’s next for the strong US dollar?

It is expected that the strong US dollar will remain high for a while. 

However, it is highly difficult to predict what the future will hold in terms of currency markets, which is why it is hard for anybody to predict whether the dollar will be able to continue to rise or fall in the near future. According to Harvard economics professor Rogoff, the strong US dollar would begin to fall if the war in Ukraine magically ended, relieving pressure on European economies and boosting their currencies. 

There is also the possibility that the strong US dollar will fall if the US enters a recession and the Fed needs to cut interest rates to stimulate the economy. Some analysts predict this could happen next year. Economic downturns in the United States may also make investing in US assets and companies less attractive, causing the dollar to fall. 

Having said that, the latest report on U.S. inflation continues to be higher than anticipated. Traders are increasing their bets on Fed rate hikes next year as a result of this. As part of their commitment to end the nation’s high inflation, the Federal Reserve has recently reaffirmed its commitment to keeping rates high “until the job is done.” The Fed’s bias toward still-higher rates should continue to support the strong US dollar value.

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