The rise in the US dollar may be painful for the whole world. Based on its current trend, the pain may be far from over. The dollar index has soared to its record high due to concerns about global growth, with the exchange rate hitting decades highs against currencies such as the euro and the yen. Given that most cross-border trade is still denominated in US dollars, this trend may become a self-reinforcement feedback loop.
JST Advisors founder Jon Turek said that may usher in an unprecedented "dord cycle" of US dollar amid higher inflation than expected and commodity prices. Meanwhile, given that Fed is hiking rates at the fastest pace in decades, it is not clear what will break this feedback loop in the coming months.
Turek pointed out that it is difficult to see whether there are factors that can stop the dollar from rising in the short term, which will make the situation even more terrible. He warned:
"At present, the problems facing Europe are putting pressure on the euro and pushing the dollar higher, further deteriorating its manufacturing cycle, leading to the repeat of the "doom cycle" of the dollar."
Although there have been periods of significant strengthening in the United States, such as in 2016 or 2018, when the Federal Reserve sought to tighten monetary policy to push the dollar up, the dollar also stopped rising as the Federal Reserve stopped intervening. Last week, the year-on-year increase in the US CPI soared to 9.1%, leaving the Federal Reserve with little room to reverse direction.
Therefore, the key question of is whether the strengthening of the US dollar can alleviate the Fed's actions to increase interest rate hikes in the coming months, thereby providing some breathing space for exporters and leveraged borrowers in other parts of the world?
Turek said it was difficult to see what could stop the dollar's rise. He guessed that the best answer was that it might stop by itself. "The question we need to start thinking is: Can the Fed achieve a hidden switch in its policy focus from interest rates to global economic conditions"? This will depend on how bad the economic growth situation (especially in Europe), especially when the year-end is really coming to the end after the FOMC meeting in September.
In the dollar loop, there are many conductive paths that enhance the dollar. For example, researchers such as Gita Gopinath of IMF and Hyun Song Shin of Bank for International Settlements have shown that the dollar plays an important role in global trade, which means that a stronger dollar may lead to a tightening of global financial liquidity and shrinking market investment.
In addition, the US dollar has a safe-haven attribute in the world market. When panic tides hit, investors often flock to safe assets denominated in US dollars, thereby pushing up the price of the US dollar. This is also one of the reasons for the dollar soaring when the market crashed in March 2020, and it is the same now.
However, what makes the current situation even more complicated is that the major central banks in the world have already or are about to enter the currency tightening mode. The European Central Bank is expected to start hikes this month, the first time since 2011. Germany is particularly in a dilemma, and it is facing a double economic blow as the price of natural gas gas has slashed its industrial output.
Turek said all central banks are dealing with high inflation and they have little tolerance for a sharp devaluation of the currency because people think that this will only amplify the pressure they deal with by hikes. Tourek added:
"I think central banks are focusing on the role of currency. We are in this reverse currency war. Of course, some currencies have more obvious roles than others... Considering the impact on the market, it makes sense for the central bank to pay full attention to currency exchange rates."
This may be one of the reasons why the Swiss National Bank unexpectedly announced its first rate hike in 15 years in June, and once the rate hike reached 50 basis points. Tourek believes that although Swiss franc is relatively strong, its actual currency value is not enough to offset inflation targets, and the Swiss National Bank is aware of this. Meanwhile, the Bank of England's Catherine Mann pointed out that the tightening of monetary policy in the United States often further pushes up inflation in the UK as the pound continues to weaken.
Recently, the strengthening of US dollar is not consistent with the forecast earlier this year. The outbreak of the Russian-Ukrainian conflict and the sanctions against Russia by Europe and the United States will become a sign of the turning point in the US dollar trend. On the other hand, it was believed at the time that the US dollar's role as the world's reserve currency would soon weaken, but the surge in the US dollar is likely to prompt countries to accelerate their search for alternative currencies.
The dollar "dord cycle" may ultimately help the Fed achieve its goal of fighting inflation to a certain extent. Tourek pointed out that this "dord cycle" is so challenging because the Fed has always emphasized that they will actively suppress inflation, but investors should pay attention to whether the Fed still needs to raise interest rates to 4.5% or similar if the dollar plays a role? He said:
"This is an interesting question in itself, but it is really hard to answer as far as what causes the current situation.
This article is derived from Jinshi Data
