US dollar: The hideous strength of the U.S. Dollar

“It’s our currency, but that’s your problem,” was a 1971 message from Richard Nixon’s Treasury Secretary John Connelly, who was dismayed by the dollar’s then-weakness to American trading partners. What was true is still true today, though in the opposite direction the greenback has risen 6% in April and 13% in the past year to its strongest level in two decades against a basket of major currencies. The Federal Reserve needs to be wary of threats to global growth from the rapid rise of the US currency.

The greenback is a logical refuge for investors seeking financial refuge from a confluence of global shocks triggered by the pandemic and intensified by Russia’s invasion of Ukraine, culminating in energy and food price hikes. The king dollar rule reigns supreme because the Fed has over the past two years maintained a policy of benign neglect in the money market, providing almost unlimited access to dollar liquidity for central banks around the world.

Barring a handful of outsiders, including the Brazilian real and the Peruvian sol, the dollar is omnipotent against every currency in both the developed and developing world. This is putting pressure on policymakers everywhere to protect their currencies or risk importing more inflation into their already troubled economies.

The monetary policy of the Fed is determined by the needs of the domestic economy. With inflation, the most important element of its mandate, rising 8.5% in March, the US central bank expects to follow March’s quarter-point interest-rate hike with an accelerated half-point hike starting this week. . The futures market anticipates a fed funds rate of at least 2.5% by the end of the year, up from 0.5% currently; The dollar’s rise reflects expectations of a change in the interest rate differential with other countries.

The strong dollar is also doing the Fed’s job of combating inflation by tightening financial conditions on a trade-weighted basis. Although the US is the world’s largest economy and a major importer of goods, it is relatively safe from shocks from global energy and food price shocks from domestic production of fuels and foods. This is also beneficial because all major commodities are priced in dollars. It is everyone’s problem when raw materials suddenly become more expensive in their respective currencies.

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Over the past half century, the world has faced several bouts of extremely strong or weak dollars. The explosion in oil prices in the 1970s culminated in a global recession, accelerated by aggressive rate hikes implemented by Paul Volcker’s Fed. His inflation-beating policies in turn revived the dollar in the mid-1980s: perceived benefits given to exporting countries of Japan and Europe versus US industry led to the 1985 Plaza Agreement, which dramatically reduced the dollar’s strength. reversed and boosted the US economy. At the expense of other countries, especially Japan.

The current weakness in the currencies of Japan and Europe would generally be welcomed to juice up their exports. But the recent fall in the Chinese yuan, the world’s second most important trade-loaded currency, puts matters in a different league. All three sectors are facing an unusual and potentially difficult problem of imported inflation. A clear and present danger of rising prices is slowing global economic growth to the extent that a recession is possible, and stagflation is a real risk.

According to Kit Jux, a currency strategist at Société Générale SA, “the dollar’s rally is like an upward avalanche.” “Like an avalanche picking up snow, rocks, trees and anything in its path as it slides down a mountain. The dollar rally has the knock-on effect of weakening more currencies. A broad-based move This, however, tightens global monetary conditions, and therefore increases economic risk.”

At some point it will start to affect the US economy and become relevant to Fed decision making, but it may take some time. To be sure, US GDP surprised at the decline, plunging at an annualized rate of 1.4% in the first quarter. But this was due to an increase in net imports, undoubtedly helped by the additional purchasing power of a stronger dollar, combined with a decline in exports.

With the Fed’s balance sheet still nearly $9 trillion, there are a lot of dollars floating around. The central bank is expected to begin actively selling off its bond holdings as soon as this summer, which could reduce overall liquidity and, as a countermeasure, make the dollar less of a haven. could. A lower dollar should in theory increase its value, but the world needs to become a better, safer place before the greenback’s uptrend can return meaningfully. For the sake of the global economy, here’s hoping the king dollar crown starts to slip.

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