In God we trust, it has been written on all United States coins and bills since President Dwight Eisenhower decreed it in the 1950s. Americans believe in the afterlife, but also in the dollar. And they’re not the only ones. Currency, in these times of war, looming recession and energy crisis, has become one of the few assets where betting money doesn’t mean losing. International investors, besieged by the red of stock markets, bonds and cryptocurrencies, have plunged into the greenback like one diving into an oasis in the middle of the desert. And its colossal appreciation against the other currencies has no small consequences for states, companies and citizens.
Compared to the rest, the forex market is not usually very volatile. Except for sporadic episodes like investor George Soros’ famous attack on sterling in 1992 or the occasional crash in emerging markets, fluctuations are usually small. But this peaceful reality is changing. Volatility is fueled by central bank interest rate hikes, changing the price of money and getting involved in a competition with national currencies that is making the dollar stronger: in contrast, the Japanese yen is down more than 20% in a year, the pound sterling and the euro are down more than 15% and the Chinese yuan depreciated more than 10%, the sharpest decline since 1994.
The dollar index, which measures its performance against a basket of currencies, is at its highest level in almost 20 years. And there are several reasons that explain his rise. The US Federal Reserve began raising interest rates ahead of other central banks and is more aggressive in raising the price of money — it has set it at 3% to 3.25%, compared to the European Central Bank’s (ECB) 1.25% — to attract more investors looking for returns. The US is less affected by the energy crisis because it is one of the world’s largest exporters of natural gas and oil, unlike Europe, which is heavily dependent on Russia. And the drums of a sharp economic slowdown are gasoline for its price due to its safe haven status, as is the case with the Swiss franc.
The most obvious consequences of this strength have to do with prices. “The depreciation of the euro contributes to rising inflationary pressures (by making its imports more expensive); and quite the contrary, in the United States, the appreciation of the dollar would help control inflationary pressures,” they explain from BBVA Research. In other words, the US exports inflation not only to Europe via the dollar, but to the whole world, because agricultural commodities are priced in this currency and energy contracts are denominated in dollars, which makes gas more expensive and oil shoots up by itself. The voices warning of the phenomenon even come from the USA. The New York Times summed up the situation this week with a simple headline: “The dollar is strong. This is good for America, but bad for the world.”
As Ignacio de la Torre, chief economist at Arcano Research, points out, there are other effects. “An expensive dollar is generally bad for dollar-leveraged emerging markets, but it also makes global exports to the US cheaper.” Traditionally, devaluations have been a means of increasing competitiveness on the assumption that if your products and services are cheaper than Your competitors, more are sold abroad. That benefit is now being diluted, according to Natalia Aguirre, director of analytics and strategy at Renta 4. “The energy shock that could push Europe into recession outweighs the positive impact of a more depreciated euro, especially as external demand also suffers in a global slowdown scenario,” he concludes. BBVA Research agrees: “In the current context, the weak euro is more a sign of concern than an opportunity to export more.”
The authorities are not standing idly by while their currencies depreciate. Japan’s finance ministry last week announced an unprecedented intervention in more than two decades aimed at preserving the value of the yen. And the Bank of England acted twice this week to try to stem sterling’s collapse after concerns in markets were sparked by the rise in debt that the UK executive’s announced tax cut plan could cause.
Olivia Álvarez, an analyst at Afi, believes the sterling collapse and UK financial instability are down to Downing Street’s unpredictable manoeuvres, which has been criticized even by the IMF. “We see a lack of coordination between monetary policy and government decisions, with a package of ultra-accommodative fiscal measures that does inflation no favors.”
In view of this turbulence, can one say that we are facing a currency crisis? “That’s too general an expression. Yes, in the singular it is correct. The pound is a good example: the three worst-performing G20 currencies in 2022 are the Argentine peso, the Turkish lira and the British pound,” recalls Arcano’s De la Torre.
Threats to proof of income
Businesses are not immune. Although many have financial instruments that protect them from currency fluctuations, others do not cover this risk. Sectors such as airlines, which pay for fuel in dollars, among other things, and often also pay for their fleet’s aircraft, see their accounts penalized.
Jorge Labarta, founding partner of FX consultancy Quant, advises a number of companies on the subject. “We have customers who are well protected by buying dollars much cheaper, below their current price; However, when that coverage runs out, they will have to come back to the market to cover themselves, and the level for that will be much worse,” he claims. As well as helping, these tools can also eliminate the beneficial part of the currency effect: for example, export firms that have chosen to be more conservative and not expose themselves to the dollar’s ups and downs are now unable to take full advantage of its appreciation.
US inflation key
On the tourist side, the most obvious impact of the currency shock is that vacations abroad are now much cheaper for Americans than they were a year ago, even though Americans are a more expensive travel destination, which can divert visitors to cheaper areas. A similar dichotomy exists between expatriate community workers in the US, whose companies pay in euros and who have lost purchasing power, and, by contrast, Americans who do their work in Europe and are paid in dollars, who are less affected by the increase living expenses are affected.
Since the greenback is already above the euro for the first time in 20 years and a similar development is taking place in other currencies, the uncertainty for investors, who have to keep a closer eye on the so-called currency risk than before, is maximum. The big question is whether there is room for the dollar rally to continue. For Labarta, everything will depend on how US inflation develops: “If it eases, the Federal Reserve would not need to raise rates any further and with the market taking the hikes for granted it would help the euro appreciate. Only the expectation of an end to the war or a clear relaxation of prices in the USA will change the trend. With the recent Russian troop mobilization and US inflation at 8.3% in August – the September figure will be known in two weeks time – neither of these two requirements appears to be met in the near term.
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