There is no place to hide: the rise of the dollar cuts through the markets

US one dollar bills are seen in this illustration taken on February 8, 2021. REUTERS/Dado Ruvic/Illustration

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LONDON, May 6 (Reuters) – “Our currency, your problem” were the words of a former US Treasury secretary in 1971 to other finance ministers horrified by the rising dollar. More than 50 years later, the relentless strength of the dollar is once again leaving a trail of destruction in its wake.

The US currency jumped to two-decade highs this week, and its strength is tightening financial conditions just as the world economy faces the prospect of a slowdown.

The increase threatens to “damage the broader market environment and expose the economic and financial cracks in the system,” said Samy Chaar, chief economist at Lombard Odier.

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The 8% gain in the dollar index this year may not be reversed any time soon.

The greenback’s safe-haven appeal is intact, with a Barclays dollar financial stress indicator near its highest level in seven years. And analysis of previous range highs and lows implies the dollar index could rise another 2% to 3%, Barclays said.

Here are some areas affected by dollar muscle flexing:

annual return USD

IMPORTED INFLATION

The latest bout of dollar strength has affected other G10 currencies, from the British pound to the New Zealand dollar, as well as those of developing countries with large balance of payments deficits.

Even the quintessential safe haven Swiss franc has not been spared, trading near a March 2020 low against the dollar.

While currency weakness typically benefits export-dependent Europe and Japan, the equation may not hold when inflation is high and rising, as imported food and fuel become more expensive as well. than the input costs of the companies.

Euro zone inflation hit a record 7.5% this month and Japanese lawmakers fear the yen, at a 20-year low, will hurt households. Half of Japanese companies expect higher costs to hurt profits, according to a survey. read more

But growth concerns may prevent central banks, especially in Europe and Japan, from adjusting policy in line with the Federal Reserve. Many believe that could push the euro back to parity with the dollar, a level not seen since 2002.

“With the risk of economic recession present, who cares how aggressive the ECB (European Central Bank) is or what is included in the rate curve?” said Kit Juckes, strategist at Société Générale.

STRICTER FINANCIAL CONDITIONS

A rising dollar helps tighten financial conditions, which reflect the availability of finance in an economy.

Goldman Sachs, which compiles the most widely used financial conditions indices (FCIs), says a 100 basis point tightening of its FCI may stunt growth by a percentage point in the year ahead.

The FCI, which takes into account the impact of the trade-weighted dollar, shows that global conditions are at their tightest level since 2009. The FCI has tightened by 104 basis points since April 1. It will also have contributed a rise of 5% in this period.

barclays index

ISSUES OF EMERGING MARKETS

Almost all past emerging market crises were linked to the strength of the dollar. As the dollar rises, developing countries must tighten monetary policy to prevent declines in their own currencies. Failure to do so would exacerbate inflation and raise the cost of servicing dollar-denominated debt.

This week, India implemented an unscheduled interest rate hike, while Chile made a 125 basis point higher-than-expected rate hike.

Median foreign currency government debt in emerging markets stood at a third of GDP at the end of 2021, Fitch estimates, up from 18% in 2013. Several countries are already seeking assistance from the International Monetary Fund and the Bank. World, and a stronger dollar. I could add to those numbers.

Investors are increasingly cautious. Emerging market currencies (.MIEM00000CUS) are at a November 2020 low, while the premium required to hold emerging market dollar bonds versus Treasuries has risen about 100 basis points this year (. JPMEGDR)

emerging market currencies

BUSINESS GAIN AND PAIN

The general rule of thumb is that a firmer dollar makes dollar-denominated commodities more expensive for non-dollar-based consumers, eventually lowering demand and prices.

That is yet to happen this time, as problems like the war in Ukraine and China’s COVID lockdowns hamper production and trade of major commodities.

The dollar’s strength generally means higher revenues for commodity exporters such as Chile, Australia and Russia, though that is offset by higher machinery and equipment costs.

But as rising US yields and a stronger dollar threaten global growth, commodity prices are beginning to suffer. JPMorgan said this week that it was reducing exposure to the Chilean peso, Peruvian sol and others to position itself for “tough times.”

US INFLATION

The Fed could welcome a rising dollar that calms imported inflation: Societe Generale estimates that a 10% appreciation of the dollar causes US consumer inflation to decline by 0.5 percentage point over a year.

With US gas prices at record highs, the dollar’s rise has so far provided little relief. Money markets expect 200 basis points of rate hikes in the US over the rest of the year and expect the Fed policy rate to peak at around 3.5% in mid-2023.

However, if upcoming US inflation data for April shows price pressures peaking, those bets could be lowered.

federal funds and dollar
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Reporting by Saikat Chatterjee and Sujata Rao; Additional reporting by Pratima Desai; Edited by Paul Simão

Our standards: the Thomson Reuters Trust Principles.

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