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Abstract:By Saikat Chatterjee and Sujata Rao LONDON (Reuters) – The dollars 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.
By Saikat Chatterjee and Sujata Rao
LONDON Reuters – The dollars race to twodecade 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 years 8 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 Japans reluctance to ditch its supereasy policies, and fears of recession in Europe.
Here are some areas affected by the dollars muscleflexing:
Graphic: FX returns this month – https:fingfx.thomsonreuters.comgfxmktzgpomlzrypdFx20returns1.
1EXPORTS
Currency weakness normally benefits exportreliant Europe and Japan, but the equation may not hold when inflation is high and rising.
Euro zone inflation hit a record 7.5 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 20year 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.
The FCI, which factors in the impact of the tradeweighted dollar, shows global conditions at their tightest since 2009. The FCI has tightened by 120 basis points in April alone, as the dollar has strengthened 5.
Emerging markets tend to have especially high levels of dollar debt. EM conditions have tightened 190 basis points this month, led by Russia, Goldmans FCI shows.p
The U.S. FCI is at its tightest since July 2020.
“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.
Graphic : Borrowing costs – https:fingfx.thomsonreuters.comgfxmktegvbkeqnzpqborrowing20costs.
3 THE EMERGING PROBLEM
Almost all past emerging market crises were linked to dollar strength. A 10.5 jump in 1993 followed by a 4.6 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 commodityexporting developing countries. But the flip side is higher debt servicing costs.
Median foreigncurrency government debt in emerging markets stood at a third of GDP by end2021, Fitch estimates, compared to 18 in 2013. Several developing countries are already seeking IMFWorld Bank assistance, and further dollar strength could add to those numbers.
Graphic : Emerging market currencies – https:fingfx.thomsonreuters.comgfxmktklvyklbkevgemerging20FX.
4NO RELIEF ON COMMODITIES
The rule of thumb is that a firmer greenback makes dollardenominated 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 UkraineRussia war has hit exports of oil, grain, metals and fertiliser, keeping prices elevated.
“When you see what‘s happening in Eastern Europe, it swamps anything the dollar is doing,” LGIM’s Onuekwusi said.
5GOOD FOR FED?
The Fed might welcome a rising greenback that calms imported inflation — Societe Generale estimates a 10 dollar appreciation causes U.S. consumer inflation to decline by 0.5 percentage points over a year.
If dollar gains continue, the Fed wont 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.
BMO Markets‘ analyst Stephen Gallo says if the Fed’s tradeweighted dollar index were to break above pandemictime highs — it is currently 2 below that level — “that might be something that would be enough to cause the Fed to deliver a lesshawkish hike next week”.
That might well mark the top for the dollar, he added.
Graphic: Fed funds target rate and the dollar – https:fingfx.thomsonreuters.comgfxmktakvezynqdprFedfundsand20dollar.
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