All of the world’s major currencies have fallen against the US dollar this year, an unusually broad shift with the potential for severe consequences across the global economy.
Two-thirds of the roughly 150 currencies tracked by Bloomberg have weakened against the dollar, whose recent strength stems from a shift in expectations about when and to what extent the Federal Reserve might cut its benchmark interest rate, which hovers around the high. of the last 20 years. .
The Fed’s high rates, a response to stubborn inflation, mean that American assets offer better returns than much of the world, and investors need dollars to buy them. In recent months, money has flowed into the United States with a force that is being felt by policymakers, politicians and people from Brussels to Beijing, from Toronto to Tokyo.
The dollar index, a common way of gauging the overall strength of the U.S. currency against a basket of its major trading partners, is hovering at levels last seen in the early 2000s (when U.S. interest rates were also equally high).
The yen is at a 34-year low against the US dollar. The euro and Canadian dollar are falling. The Chinese yuan has shown notable signs of weakness despite authorities’ stated intention to stabilize it.
“It has never been more true that the Fed is the world’s central bank,” said Jesse Rogers, an economist at Moody’s Analytics.
When the dollar strengthens, the effects can be quick and far-reaching.
The dollar is present in almost 90% of all foreign exchange transactions. The strengthening of the U.S. currency intensifies inflation abroad, as countries need to exchange more of their own currencies for the same amount of dollar-denominated goods, which includes imports from the United States as well as globally traded goods such as oil, often quoted in dollars. Countries that borrowed in dollars also face higher interest bills.
However, there may be benefits for some foreign companies. A strong dollar benefits exporters who sell to the United States, since Americans can buy more foreign goods and services (including cheaper vacations). This puts American companies selling abroad at a disadvantage as their products appear more expensive, and could increase the US trade deficit at a time when President Biden is promoting more domestic industry.
Exactly how these positives and negatives play out depends on why the dollar is stronger, and that depends on why US interest rates might remain high.
At the start of the year, unexpectedly strong U.S. growth, which could boost the global economy, began to outweigh concerns about persistent inflation. But if U.S. rates remain high because inflation is sticky even as economic growth slows, then the effects could be more “sinister,” said Kamakshya Trivedi, an analyst at Goldman Sachs.
In that case, policymakers would be stuck between supporting their domestic economies by reducing rates, or supporting their currency by keeping them high. “We are on the brink of this,” Trivedi said.
The effects of the strong dollar were felt particularly sharply in Asia. This month, the finance ministers of Japan, South Korea and the United States met in Washington and, among other things, pledged to “consult closely on developments in the foreign exchange market”. His post-meeting statement also highlighted the “serious concerns of Japan and the Republic of Korea about the recent sharp devaluation of the Japanese yen and Korean won.”
The Korean won is the weakest since 2022, and the country’s central bank governor recently called moves in the foreign exchange market “excessive.”
The yen has been falling against the dollar and on Monday briefly passed 160 yen to the dollar for the first time since 1990. In sharp contrast to the Fed in the United States, Japan’s central bank has begun raising interest rates. interest only this year, after difficulties during decades of low growth.
For Japanese policymakers, that means striking a delicate balance – raising rates, but not too much, in a way that could stifle growth. The consequence of this balance is a weakened currency as rates have remained close to zero. The risk is that if the yen continues to weaken, investors and consumers could lose confidence in the Japanese economy, moving more of their money abroad.
A similar risk looms over China, whose economy has been hit by a housing crisis and sluggish domestic spending. The country, which seeks to keep its currency within a tight range, recently relaxed its position and allowed the yuan to weaken, a demonstration of the pressure exerted by the dollar on financial markets and political decisions in other countries.
“A weaker yuan is not a sign of strength,” said Brad Setser, a senior fellow at the Council on Foreign Relations and a former Treasury Department economist. “This will lead to questions about whether China’s economy is as strong as people thought.”
In Europe, policymakers at the European Central Bank signaled they could cut rates at their next meeting in June. But even as inflation improves in the eurozone, there is concern among some that by lowering interest rates before the Fed, the ECB would widen the interest rate gap between the eurozone and the United States, weakening it further. the euro.
Gabriel Makhlouf, governor of Ireland’s central bank and one of the 26 members of the ECB board, said that in setting policy, “we cannot ignore what is happening in the US”.
Other policymakers face similar complications, with the central banks of South Korea and Thailand among those also considering cutting interest rates.
In contrast, Indonesia’s central bank unexpectedly raised rates last week, in part to support the country’s depreciating currency, a sign of how the dollar’s strength is resonating around the world in different ways. Some of the currencies that have fallen the most this year, such as those of Egypt, Lebanon and Nigeria, reflect internal challenges made even more frightening by the pressure exerted by a stronger dollar.
“We are on the brink of a storm,” said Rogers of Moody’s.
Eshe Nelson contributed reports.
