Ewidespread international complications and realignment is created by the revision of the outlook for the US economy and interest rates, as the recovery of the dollar is now proving sustainable and promising, while at the same time the phase difference with the ECB and other central banks is causing turbulence with direct and calculable geoeconomic impacts.
A strong dollar is developing into a major issue internationally as it defies analysts’ forecasts and is supported by divergent data at the fundamental level, leading to an aggressive re-adjustment of many managers’ stances and more.
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The unexpectedly high resilience of the US economy, persistent inflation forcing the Fed to extend restrictive interest rates, as opposed to the ECB, and international geopolitical tensions have created a new geoeconomic environment that supports the strong dollar.
Although forecasts for 2024 saw a weaker dollar, investors were forced to reconsider their stance, given the resilience of the US economy and persistent inflation. The Fed is forced to keep interest rates at restrictive levels for an extended period, while the ECB has made it clear that cuts will begin in June. This creates an arbitrage scenario between exchange rates and assets.
Also, the International Monetary Fund predicts that US output will grow at twice the rate of the G7, talk of “American exceptionalism” is rife and is supporting stock and bond yields, increasing the dollar’s appeal. And in an era of heightened geopolitical conflict, the currency still remains the ultimate monetary haven.
In the markets, the situation is recorded by the indices with that of the dollar from Bloomberg which has gained more than 4% this year, reflecting the rise against all major developed and emerging markets. A popular trader sentiment indicator that moved lower at the start of the year has now rebounded and is posting its biggest gains since 2019.
Among those upgrading their dollar strategies is Vanguard Group Inc., the world’s second-largest fund manager, which now forecasts a solid bullish outlook.
“If other countries can’t match US growth and inflation, there’s simply no choice but to buy the dollar,” says Ales Koutny, head of international prices at Vanguard.
“What was a very tactical trade for us before has become much more of a long-term structural view around maintaining the dollar and US economic strength.”
For its part, UBS Asset Management argues that the dollar is likely to strengthen further despite being 20% more expensive than it is usually valued at. Meanwhile, the Wells Fargo Investment Institute capitulated on forecasts for weakness through the end of the year and now expects the rally to extend into 2025.
The dollar rally
The dollar’s resurgence followed a series of signs that the US economy had avoided the slowdown many had expected. The labor market has remained tight and manufacturing activity continues to expand. The subsequent persistence of inflation has led Fed Chairman Jerome Powell and others to wait longer than expected to cut interest rates.
New York Fed President John Williams even suggested the possibility of resuming interest rate hikes, under conditions.
The impact
Of course, the rise of the global reserve currency comes at a price to its counterparts and their economies, which traders are also trying to address. India and Nigeria are among countries seeing their exchange rates fall to historic lows, while threats of intervention are being heard from Japan to Poland.
Central banks in developed markets such as Australia, the Eurozone and the UK may find their room to cut rates limited if lower exchange rates fuel domestic inflation. Countries burdened by foreign debt, including the Maldives and Bolivia, as well as those heavily dependent on US imports, may be the hardest hit.
In a sign of growing concern caused by the dollar’s rapid rise, the G7 earlier this month reaffirmed their common stance on the potential damage from erratic currency moves. It was preceded by the recognition by the US Secretary of the Economy, Janet Yellen, of the special conditions created for Japan and South Korea, due to the rapid sliding of their currencies.
