During times of turmoil, investors tend to stow their assets in a safe haven. This is usually the US dollar. It has been the world’s primary reserve currency since the end of World War II. It has been strengthening for some time, but it has now climbed to its highest levels in more than two decades.
The Federal Reserve’s latest move, to raise interest rates, has added to the strength of the greenback. It has been the fastest rate-hike cycle in modern history. It is also raising inflation-adjusted interest rates. Market observers expect another percentage point increase by the end of the year.
A stronger dollar could hurt American exporters, but it could also make U.S. jobs more likely. That’s a reason why the Federal Reserve has moved aggressively in this direction. If the Fed were to ease policy, the dollar’s trajectory would quickly change.
A stronger dollar puts more pressure on stocks and shares. A weaker dollar would allow companies to sell their goods and services in other countries for a lower cost. This makes American goods less attractive to shoppers in those countries. This can lead to trade imbalances. This is not something priced into earnings estimates for the next few years.
A strong dollar can also strain emerging markets. Countries with large foreign debt, such as China and Japan, are being weighed down by high global demand for dollars. These economies are experiencing lower global demand for manufactured goods and are struggling to offset this drop. The combination of increased inflation and deleveraging is one of the reasons why the dollar has been on a steady climb.
The dollar has strengthened against the euro, renminbi, British pound and the Japanese yen. The euro dropped as much as 1.3% to $1.0005 on Tuesday. In contrast, the yen has hit its lowest level in almost two decades. The renminbi, which is considered the world’s main reserve currency, is not commonly cited as an alternative.
The dollar’s relative strength is extreme. The dollar is now near its highest level against the British pound in more than two decades. It has also reached parity against the 19-member euro. If this trend continues, the dollar could go even higher.
As the dollar increases in value, the demand for Treasury notes in the United States increases. It’s a good thing for Americans. This is one of the primary reasons why the dollar is on its way to becoming the strongest currency in more than two decades. Adding to this pressure, the Fed has hiked interest rates more aggressively than other central banks. If the Fed believes that inflation is imminent, it may accelerate its path of rate hikes.
The dollar is also gaining ground against the Chinese renminbi. The yen recently hit its lowest level since 1998. This is also a concern for European economies, which are seeing dramatically higher energy costs. This has led to a decline in the value of diversified emerging markets. It’s also causing concerns for investors in the developed world.
