The appreciation of the dollar may be painful for the whole world, but according to the current trend, the pain may be far from over. Concerns about global economic growth have recently brought the Bloomberg dollar index to an all-time high, with the dollar reaching decades of hi

The appreciation of the dollar may be painful for the whole world, but based on the current trend, the pain may be far from over.

Recently, concerns about global economic growth have brought the Bloomberg dollar index to an all-time high, with the U.S. dollar hitting a decades-long high against currencies such as the euro and the Japanese yen. However, nothing seems to reverse this trend at the moment. Given that the vast majority of cross-border trade is still denominated in US dollars, and the strengthening of the US dollar has historically had a wide impact on the global economy, this trend of the US dollar is likely to become a self-reinforcement feedback loop. Jon Turek, founder of JST Advisors and a blogger of Cheap Convexity, a policy research firm, said that in the context of higher inflation than expected and the price of commodities is still at a high level, people are worried that the US dollar is in an unprecedented "vicious cycle".

He said that as Feder raises rates at the fastest speed in decades, it is not clear what is possible to break this feedback loop in the next few months.

But Turek said: "What makes this vicious cycle really scary is that it's hard to see how similar circuit breaker will work in the short term. Europe is in a dilemma, which puts pressure on the euro and pushes the dollar higher, and also worsens the manufacturing cycle in the region, which will replay the whole process. At the same time, people may think, can the Fed keep spot inflation at 8%?"

In fact, before that, the US dollar also had a period of significant strength - such as 2016 or 2018. At that time, the dollar rose as the Fed tried to tighten its policy, but once the Fed stopped intervening, the dollar stopped rising. However, according to data released last week, U.S. CPI soared 9.1% year-on-year in June, giving the Fed a significantly reduced room for maneuver to reverse its policy.

So the key question here should be to what extent does the US dollar strengthening reduce the tendency of the Fed to raise interest rates further in the coming months, which may provide some relief for exporters and leveraged borrowers around the world?

"It's hard to see what measures can stop this, and I think the best answer is that it can stop on its own," Turek said. "The question we should start thinking is whether the Fed can somehow achieve a hidden shift in focus from interest rates to global economic conditions, depending on how bad the economic growth is, especially in Europe, and after FAP (FOMC) in September, or by the end of the year."

There are many transmission channels in the dollar cycle that can strengthen the dollar. For example, researchers such as Gita Gopinath of International Monetary Fund (IMF) and Hyun Song Shin of Bank for International Settlements (BIS) have shown that the role of the dollar in global trade means that a stronger dollar may lead to tightening of global financial conditions and hit actual investment.

And because the dollar has a special position in the global market, when investors are worried, they tend to flock to safe dollar-denominated assets, pushing the dollar further up. That's one reason why the dollar soared when the market crashed in March 2020 and now the dollar is strengthening.

But what makes the current situation even more complicated is that major central banks around the world are now tightening their monetary policy, or are about to tighten them. The market expects the ECB to start hikes for the first time this month since 2011, which will put European countries in economic shocks, especially Germany, which has been affected by the surge in gas prices.

Turek said: "The world we are in now is that all central banks that deal with higher than target inflation are beyond tolerant of a sharp depreciation of currencies because people think that this will only amplify the pressure they deal with by hikes. We are in this reverse currency war, and I think that major central banks are clearly emphasizing the role of currencies. Given the nature of the impact, it makes sense that major central banks are paying a very large and comprehensive attention to currency issues."

On the other hand, for the United States, the vicious cycle of the dollar may eventually play a role in fighting inflation."This vicious cycle is so challenging because it almost becomes a positive condition or external effect of the Fed's efforts to reduce inflation quickly. So market participants should think here if the US dollar plays all these roles, does the Fed have to raise interest rates to 4.5% or similar?"