The US dollar seems to be going up non-stop at least until the time when some of the causes pushing it from behind will turn otherwise. The value of the dollar is rising to multi-decade highs and undervaluing currencies around the world, largely due to the Federal Reserve’s aggressive tightening policy and further aided by global investors trying to shift assets to the perceived safety of the U.S. in the face of uncertainty prompted by Russia’s invasion of Ukraine.
The dollar has now nearly reached its extreme from 1998, set in the aftermath of the Asian financial crisis against the currencies of two major Asian exporters, Japan and South Korea, as the market is merely a representation of the underlying economy.
While even developed countries like Japan, whose more than 90% of energy consumption relies on imports, are fighting against the crisis created by the rising dollar, its straight impact on the emerging market countries is likely to still increase because many of them have been encouraged by US policymakers, investors and corporations to tie their currencies to the US dollar. The strong dollar squeezes poorer countries as they must meet their debt obligations in dollars and rely on the US for food imports.
In such a situation, Fed officials have repeatedly said that they’ll likely continue rate hikes into 2023, so there’s little relief coming.
Even S&P 500 companies that have a global footprint are dealing with the strong dollar making a dent in their revenue growth because, as they say, 30% of all S&P 500 companies’ revenue is earned in markets outside the US.
Although some analysts say that the strength of the dollar should stop accelerating when the Fed stops hiking, additional outside forces are still strong enough to keep the USD’s value sky-high even after the FOMC calls it a day. For example, the current weakness of the euro, which has fallen -0.60% – to its lowest levels against the dollar in two decades – and other currencies reflect fears from investors of an impending recession in Europe; it isn’t just about the Fed.
A strong dollar helps hold down domestic inflation, by lowering the cost of imported goods. Every dollar buys more goods and services as it rises. Since the U.S. is a large net importer, a 14% rise in the dollar can have a measurable impact on inflation.
The USD/JPY pair, which is one of the most traded pairs in the foreign exchange market, representing a significant quantity of daily trading, can also be a determinant of market risk.
Stronger inflation will be a direct consequence of a persistently weak yen, as higher import goods prices and higher input costs for firms will result. Since the US dollar is the currency used in the majority of international transactions, the yen’s further fall against the dollar will raise the cost of grains, fossil fuels, and various metal commodities.
However, this year, the impact of a weaker yen on Japan’s exporting sector would be limited. Rising input costs will remain a significant obstacle for manufacturers. It will be more challenging for Japanese exporters to increase their outbound exports as a result of the war between Russia and Ukraine. The war will hamper private consumption and economic growth in Europe, which will reduce orders in a key international market for Japanese businesses.
It seems unlikely that the Bank of Japan will tighten policy any time soon, though. Although European inflation is also high, the European Central Bank is being more cautious. This is partially due to the eurozone’s more unstable economic outlook. While the ECB is alarmed about Italy’s high debt levels, it also considers that the current rates of inflation in energy prices won’t last.
Although world economic history has already witnessed some big run-ups in the dollar’s value, including in the mid-1980s and the early 2000s, which were eventually followed by sharp declines, the expectation of a reverse in the near future will prove to be an over expectation. It’s because the Fed’s policy and the financial insecurity caused by the ongoing Russia-Ukraine war are not likely to be altered any time soon.
Just nations need to prepare themselves to deal with still harder blows of financial crises, including inflation, as the dollar is not likely to stop rising in the near future.