Dollar dominance rattles global markets amid policy uncertainty

Finance ministers from around the world convened in Washington this week, grappling with a pressing concern: the soaring value of the U.S. dollar against major currencies is posing challenges for economic policymakers worldwide. The surge in the dollar’s value is of significant consequence. As it strengthens, other major currencies weaken, exacerbating inflationary pressures in countries already struggling to contain rising prices. Moreover, dollar-denominated debts held overseas, particularly prevalent in emerging markets, become increasingly burdensome, constraining economic activity.

This situation prompts difficult decisions in some nations regarding whether to intervene to support their currencies in a bid to stem capital outflows, reminiscent of Indonesia’s recent actions. In the broader context, the U.S. economy continues its robust expansion, defying Federal Reserve rate hikes. Consequently, expectations for Fed interest rate cuts are pushed back, leading to higher yields on U.S. treasury securities and other financial assets. This hawkish stance adopted by the Fed contrasts starkly with the approaches of other central banks, notably the European Central Bank, which signals a potential rate cut in June.

Meanwhile, the underpinning factors driving U.S. economic growth, including substantial investments in manufacturing capabilities and the dominance of tech giants, attract global investors to dollar assets, further bolstering the dollar’s supremacy. By the metrics, the dollar index, gauging the dollar against six major advanced economy currencies, has surged by 5% since its recent low on December 27. Several Asian nations have experienced even more pronounced currency fluctuations. Notably, the South Korean won has depreciated by 6.1% against the dollar this year.

Bloomberg’s calculations underscore the severity of the situation, with the Taiwanese dollar hitting an eight-year low against the dollar this week, the Malaysian ringgit plunging to a 26-year low, and the Indian rupee reaching an all-time nadir despite robust domestic growth. Christine Lagarde, President of the European Central Bank, acknowledged the divergence between the euro and the dollar, emphasizing the ECB’s careful monitoring of currency movements. She underscored the potential inflationary impact resulting from currency fluctuations, eliciting amusement from attendees during an event at the Council on Foreign Relations.

In this volatile landscape, the once-certain prospect of Federal Reserve rate cuts has been cast into doubt as inflationary pressures emerge and the strength of the dollar prompts central banks worldwide to reassess their policy strategies. As earnings season unfolds, the likelihood of Federal Reserve rate cuts in the near term appears increasingly improbable and uncertain, causing concern among investors and policymakers alike.