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The strong dollar has wreaked havoc around the world. And this is just the beginning

— Dollar climbed even higher on Fed rate hikes and global recession fears

– The US currency does not have an “Achilles heel” that can weaken it in the near future

George Boubouras was sitting at his home in east Melbourne watching a cricket match when the phone suddenly rang.

It was July 13, about fifteen minutes to eleven in the evening. All those who called and wrote SMS messages to him expressed alarm and concern. The euro has just collapsed against the dollar, equaling it in value, which was simply unthinkable before. And everyone – clients, fund managers, traders – wanted to know what Bubouras, head of research at K2 Asset Management, would recommend to them. His answer was simple: “Don’t go to war with the dollar now.”

An hour later there was another shock. The Bank of Canada, like the European Central Bank and other central banks trying to strengthen its currency against the dollar, increased interest rates by a full point. Almost no one expected this. Ten hours later, there was another shock: the Singapore Monetary Authority broke into the foreign exchange market and announced its decision to strengthen the Singapore currency against the dollar.

At this point, Mitul Kotecha’s phone started ringing continuously. This strategist based in Singapore at TD Securities was vacationing with his wife at a resort in Thailand. It was their 25th anniversary and Koteja was lying on the beach. What happened seemed to him something incredible. “It all happened insanely fast,” he said. “I couldn’t believe the commotion.”

The dollar, which powers world trade, has gone up at a pace that is almost unprecedented in modern history. Its strengthening is mainly the result of an aggressive increase in interest rates by the Federal Reserve. On Wednesday, he raised them by another 75 basis points, leaving ruins in his wake. Imported food prices rose, poverty increased in many parts of the world, debt defaults began, the government of Sri Lanka was overthrown, investors in securities and bonds everywhere suffered huge losses.

Today, the dollar is stronger than ever, according to some estimates. Since mid-2021, it has risen by 15% against a number of currencies. And since the Fed is determined to keep raising rates to dampen inflation (even if it sinks the US and causes a recession in the global economy), experienced observers of the US currency believe that nothing can stop the dollar from rising.

All this is a bit like the anti-inflationary campaign of the early 1980s, led by Paul Volcker of the Fed. Therefore, there are more and more talks about a possible repetition of the Plaza agreement, which was concluded by the bigwigs of politics in order to artificially curb the dollar. Now, a similar deal is unlikely, but some market speculation indicates that the dollar could easily rise by about the same amount again. Such an increase would shock the global financial system and cause all sorts of additional problems. It’s just a matter of time.

“Right now, the dollar doesn’t have an Achilles heel that can weaken it immediately. The eurozone is hampered by the conflict in Ukraine, and with the rise of China there are many uncertainties,” says Vishnu Varathan, economics and strategist at Singapore-based bank Mizuho. there is no alternative, and wherever you look, he is wreaking havoc and destruction everywhere. These are the economies and currencies of other countries, the income of corporations.”

The rapid appreciation of the US currency is being felt in everyday life around the world because it is the lubricant of global trade. Approximately 40% of the $28.5 trillion in world trade annually is carried out in US currency. The inexorable growth of its rate can lead to a self-sufficient vicious circle.

“There is a recessionary fear leading to a stronger dollar, there is a tightening of financial conditions leading to new recessionary fears,” said Joey Chew, a strategist at Hong Kong firm HSBC Holdings, “and there is no way to fix this immediately.” .

Demand for the dollar is strong for one simple reason: When world markets go crazy, investors look for a safe haven. And according to the Bank for International Settlements, such security “now provides mainly the US dollar.” The American economy continues to be unmatched in strength and size. US securities remain one of the safest means of holding money, and the dollar makes up the lion’s share of the world’s foreign exchange reserves.

By some measures, the dollar may further strengthen. Although Bloomberg’s spot dollar index reached a record high this month, it has only been active since the end of 2004. The narrower ICE US dollar index, which measures its performance against peer currencies in developed countries, is still well below the level seen in the 1980s. It would take a 54 percent rally to bring it back to its peaks in 1985 when the Plaza agreement was signed.

But this time things have changed, said Brendan McKenna, a New York-based strategist at Wells Fargo Securities. The strength of the dollar is not as visible, at least not yet, and the Fed should cut rates at some point next year when the economy cools off, easing pressure on the dollar. “Coordinated actions to devalue the dollar and support G-10 currencies, apparently, are not such a priority at this stage,” he said.

Yet the currencies of many major economies are suffering. In addition to the fall in the euro, the Japanese yen has fallen to a 24-year low as investors seek higher yields.

In many emerging markets, the damage was even worse. The Indian rupee, Chilean peso and Sri Lankan rupee have fallen to record lows this year despite efforts by some central banks to slow the decline. The Hong Kong Monetary Authority has been buying up local dollars at a record pace to protect the city’s currency peg, while Chile’s central bank launched a $25 billion intervention after the peso fell more than 20% in just five weeks.

“It won’t work,” said Luca Paolini, a strategist at Pictet Asset Management Ltd., which manages $284 billion. “This rise in inflation and the dollar is a generational defining event, and central banks emerging markets can’t do anything about it.”

A strong dollar boosts the profits of oil producers and commodity exporters, as well as international corporations such as Toyota Motor Corp., which record most of their income in the US. It’s also a boon for American tourists, like 33-year-old Fresno teacher Mila Ivanova. “A strong currency helps my budget,” said Ivanova, who has arrived in London and is heading to Scotland and Ireland.

But the mighty dollar smashes and crushes everything else.

Tech giants that are returning some of their overseas earnings to the US have been hit hard. Microsoft said the dollar was eating into its profits, while International Business Machines blamed the strong dollar for pressure on cash flows.

For those who want to challenge the dominance of the dollar, Wall Street advises not to waste energy. Fund managers from Bank of America Corp. conducted a study and concluded that the bullish dollar rose to its highest level in seven years.

“Only when investors are ready to support risky assets again, we can expect a reversal in the dollar rate. But this will not happen until the market is convinced of the Fed’s change in the rate,” said Jane Foley of Rabobank.

There have been periods of dollar strength before, such as in 2016 and 2018, when the Fed sought to tighten policy. But the latest data indicates that US inflation is at its highest level in four decades, and the Fed has less room to maneuver in such a situation. Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen make little mention of the recent strengthening of the US currency.

dollar smiles

Against this background of soaring prices, aggressive actions by the Fed and the risk of a global recession, the dollar is smiling. So goes the widely accepted concept developed by former Morgan Stanley currency guru Stephen Jen. His theory is that the currency strengthens at two extremes – when the US economy is in deep decline, and when it is growing rapidly. And in the middle, during periods of moderate growth, it weakens.

Garrett Melson of Natixis Investment Managers believes that this time the buck’s smile looks more like a grim grin.

“Macroeconomic forces this year have sent the dollar into 2010 mode, which is more like a vicious circle than a smile,” Melson, whose company manages more than $1.30 in capital, wrote in a memo. trillion dollars. Growth in the US is fairly robust, which is boosting demand for dollars. There is pressure on the world economy, and this further increases the demand for dollars and US securities, which are considered safe. “So we’re going in circles,” Melson said.

How to break this vicious circle? Investors from Singapore to New York are theorizing about catalysts such as a slowdown in growth, clarity about when the Fed will stop raising rates, and a substantial recovery in China’s economic growth. But it’s unclear when that will happen. The US CPI rose to a new high of 9.1% in June, and the Fed hasn’t raised rates this fast since the mid-1990s.

Since then, the world economy has changed a lot. For three decades, Chinese manufacturing growth has held back the prices of millions of manufactured goods, even as the cost of raw materials has risen. When the supply of cheap labor and capital in this Asian country began to decline, price pressure began to build up again. Then came the trade war with the United States, the pandemic and the sting operation in Ukraine, which threw a well-balanced global trading system into chaos and sent energy prices skyrocketing. With the world’s second economy still sticking to its zero-COVID policy, even at the cost of slowing growth, a return to normality seems unlikely.

With uncertainties abound, central banks from Australia to Canada have no choice but to follow the US lead and raise borrowing costs to fight inflation. And until there is more clarity as to when this cycle may end, very few investors will be willing to bet against the dollar.

“While it’s an all-time high, that doesn’t mean everyone is ready to leave their positions,” said HSBC’s Joey Chu. “We don’t think there’s going to be a reversal at this point.”

Authors: Ruth Carson, Cormac Mullen

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