All of the world’s major currencies have weakened against the US dollar this year, and the unprecedented large-scale fluctuations could have a serious impact on the global economy as a whole.
Two-thirds of the roughly 150 currencies tracked by Bloomberg have weakened against the dollar. The dollar’s recent strength has been driven by changing expectations about when and how much the Federal Reserve will cut its benchmark interest rate, which is near a 20-year high. .
The Fed’s high interest rates, a response to stubborn inflation, mean that U.S. assets yield better returns than many assets in the world, and investors need dollars to buy them. There is. In recent months, money has flowed into the United States at a rate that has been felt by policymakers, politicians, and people from Brussels to Beijing, Toronto to Tokyo.
The dollar index, a common measure of the overall strength of the U.S. currency relative to a basket of major trading partners, is hovering at levels not seen since the early 2000s (when U.S. interest rates were similarly high).
The yen is at a 34-year low against the US dollar. The euro and Canadian dollar are falling. China’s yuan is showing notable signs of weakening, despite officials saying they aim to stabilize it.
“It’s never been more true that the Fed is the central bank of the world,” said Jesse Rogers, an economist at Moody’s Analytics.
When the dollar strengthens, the effects can be rapid and far-reaching.
Nearly 90% of all foreign exchange transactions involve dollars on one side. A rise in the U.S. currency intensifies inflation overseas. Countries will need to exchange more of their currency for the same amount of dollar-denominated goods, including imports from the United States and globally traded goods such as oil, which is often priced in dollars. included. Countries that borrow in dollars also face higher interest charges.
However, it may be of benefit to some foreign companies. A stronger dollar benefits exporters selling to the United States because Americans can afford to buy more foreign goods and services, including cheaper vacations. That puts U.S. companies selling overseas at a disadvantage as their products appear more expensive and could widen the U.S. trade deficit as President Biden boosts domestic industry.
Exactly how these pluses and minuses change depends on why the dollar is strong, which in turn depends on why U.S. interest rates remain high.
Earlier this year, unexpectedly strong U.S. growth that could boost the global economy began to outweigh concerns about stubborn inflation. But Goldman Sachs analyst Kamaksha Trivedi said the impact could be more “sinister” if inflation persists and U.S. interest rates remain high even as economic growth slows. Ta.
In that case, policymakers would be torn between supporting the domestic economy by cutting interest rates or supporting the domestic currency by keeping the currency strong. “We’re right at the pinnacle,” Trivedi said.
The impact of the strong dollar is particularly noticeable in Asia. This month, the finance ministers of Japan, South Korea and the United States met in Washington and pledged, among other things, to “closely discuss developments in foreign exchange markets.” The statement after the meeting also noted that Japan and South Korea have “serious concerns about the recent sharp depreciation of the Japanese yen and Korean won.”
South Korea’s won is at its lowest since 2022, and the country’s central bank governor recently called movements in the currency market “excessive.”
The yen has been depreciating against the dollar, briefly exceeding 160 yen to the dollar on Monday for the first time since 1990. In contrast to the U.S. Federal Reserve, Japan’s central bank only started raising interest rates this year after a difficult period. Low growth continued for decades.
For Japanese officials, that means striking a delicate balance. The goal is to raise interest rates, but not so excessively that they stifle growth. As interest rates remained near zero, the result of that balancing act was a weaker currency. The risk is that if the yen continues to weaken, investors and consumers could lose confidence in Japan’s economy and move more money overseas.
Similar risks loom in China, whose economy has been hit hard by the real estate crisis and slumping domestic consumption. The country, which seeks to keep its currency within a narrow range, has recently eased its stance by allowing the yuan to weaken, an indication of the pressure the dollar exerts on financial markets and other countries’ policy decisions.
“A weak yuan is not a sign of strength,” said Brad Setzer, a senior fellow at the Council on Foreign Relations and a former Treasury economist. “It will lead to questions about whether China’s economy is as strong as people think.”
In Europe, European Central Bank policymakers have indicated they may cut interest rates at their next meeting in June. However, even though inflation in the euro area is improving, there are concerns that if the ECB lowers interest rates before the Fed, the interest rate differential between the euro area and the United States will widen, leading to further depreciation of the euro. There are also some.
“We cannot ignore what is happening in the United States” when making policy decisions, said Gabriel Makhlouf, head of Ireland’s central bank and one of the 26 ECB executive board members.
Other policymakers are facing similar complexities, with central banks in South Korea and Thailand considering lowering interest rates.
By contrast, Indonesia’s central bank unexpectedly raised interest rates last week to support the weaker currency, a sign that the dollar’s strength is spreading across the world in more ways than one. Some of the sharpest declines in currencies this year, including Egypt, Lebanon and Nigeria, reflect domestic challenges made more difficult by pressure from a stronger dollar.
“We’re on the brink of a storm,” Moody’s Rogers said.
Eshe Nelson Contributed to the report.