All of the world’s major currencies have fallen against the US dollar this year, an unusually large swing with the potential to have serious consequences across the global economy.
Two-thirds of the roughly 150 currencies tracked by Bloomberg have weakened against the dollar, whose recent strength is due to a shift in expectations about when and by how much the Federal Reserve might cut its benchmark interest rate, which stands at around a maximum of 20 years. .
The Federal Reserve’s high rates, a response to persistent inflation, mean U.S. 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 to measure the overall strength of the U.S. currency against a basket of its major trading partners, is hovering around levels last seen in the early 2000s (when U.S. interest rates were also similarly high). high).
The yen is at its lowest level in 34 years against the US dollar. The euro and the Canadian dollar are falling. The Chinese yuan has shown notable signs of weakness, despite officials’ stated intention to stabilize it.
“It has never been more true that the Federal Reserve is the world’s central bank,” said Jesse Rogers, an economist at Moody’s Analytics.
When the dollar strengthens, the effects can be swift and far-reaching.
The dollar is involved in almost 90 percent of all currency transactions. A strengthening U.S. currency intensifies inflation abroad as countries need to exchange more of their own currencies for the same amount of dollar-denominated goods, including U.S. imports as well as globally traded commodities such as oil, often quoted in dollars. Countries that have borrowed in dollars also face higher interest rates.
However, there may be benefits for some foreign companies. A strong dollar benefits exporters selling to the United States, as Americans can afford to buy more foreign goods and services (including cheaper vacations). That puts U.S. companies that sell abroad at a disadvantage as their products appear more expensive and could widen the U.S. 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 U.S. interest rates might remain high.
Earlier in the year, unexpectedly strong U.S. growth, which can boost the global economy, had begun to offset 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 “ominous,” said Kamakshya Trivedi, an analyst at Goldman Sachs.
In that case, authorities would be caught between supporting their national economies by cutting rates and supporting their currency by keeping them high. “We’re on the cusp of that,” Trivedi said.
The effects of the strong dollar have been felt especially 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 Japan and the Republic of Korea’s “serious concerns over the recent sharp depreciation 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 currency market “excessive.”
The yen has been falling against the dollar, falling below 160 yen per dollar on Monday for the first time since 1990. In stark contrast to the U.S. Federal Reserve, Japan’s central bank began raising interest rates just this year after struggling for decades with low growth.
For Japanese officials, that means striking a delicate balance: Raise rates, but not so much that it could stifle growth. The consequence of that balancing act is a weakened currency, as rates have remained near zero. The risk is that if the yen continues to weaken, investors and consumers could lose confidence in the Japanese economy and move more of their money abroad.
A similar risk lurks in China, whose economy has been hit by a housing crisis and sluggish spending at home. The country, which seeks to keep its currency within a narrow range, recently relaxed its stance and allowed the yuan to weaken, a demonstration of the pressure exerted by the dollar on financial markets and on the political decisions of other countries.
“A weaker yuan is not a sign of strength,” said Brad Setser, a fellow at the Council on Foreign Relations and former Treasury Department economist. “This will raise questions about whether China’s economy is as strong as people thought.”
In Europe, European Central Bank officials have signaled they could cut rates at their next meeting in June. But even with inflation improving in the eurozone, some fear that by lowering interest rates ahead of the Federal Reserve, the difference in interest rates between the eurozone and the United States would widen, further weakening the euro.
Gabriel Makhlouf, governor of Ireland’s central bank and one of the 26 members of the ECB’s governing council, said that in setting policy, “we cannot ignore what is happening in the United States.”
Other authorities face similar complications, and the central banks of South Korea and Thailand are among those also considering cutting interest rates.
By contrast, Indonesia’s central bank unexpectedly raised rates last week, in part to support the depreciation of the country’s currency, a sign of how the dollar’s strength is reverberating around the world in different ways. Some of the currencies that have fallen most rapidly this year, such as those of Egypt, Lebanon and Nigeria, reflect domestic challenges that have been made even more daunting by the pressure exerted by a stronger dollar.
“We are on the brink of a storm,” said Moody’s Rogers.
Nelson Nelson contributed with reports.