Currencies | The dollar is expected to weaken for years, and its impact on the world could be large

The exchange rate of the US dollar rose very strongly last year, but after the autumn peaks, the currency has weakened. Some investors expect the dollar to weaken even for years.

of the United States The dollar has held its place as the reserve currency and the most important medium of exchange worldwide for a long time. The majority of international trade runs in dollars, so does the debt market.

Because of its central position, changes in the dollar’s exchange rate are seen far outside the United States, and their effects can be significant.

During the last year, the dollar has been very strong. The Dollar Index, which compares the dollar’s exchange rate to other leading currencies, has been higher than it is now at the beginning of the 2000s, and the slightly broader Bloomberg Dollar Spot Index was at a record high in September, although its calculation was only started at the end of 2004.

In indices comparing the value of the dollar, the biggest weight is given to the euro, which was more valuable than the dollar for almost 20 years, until last summer it first sank to the level of the dollar and then below it.

Many from that point of view, the dollar was hit too hard last year. The strong rise of the dollar has been viewed as the worst already threatening the stability of the world economy.

A strong dollar is a problem especially for developing economies, which often depend on financing in dollars, even though they receive their income mainly in other currencies. When the dollar strengthens, the borrowing costs of many companies or countries increase, but the income decreases, at least when measured in dollars.

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The strengthening of the dollar also makes it difficult for the rest of the world to try to curb inflation that has accelerated faster than the goals, when the prices of goods or services bought in dollars rise even more in the local currency.

Read more: The dollar runs the world economy, but now it has already become too strong a currency.

Last however, after the autumn peaks, the value of the dollar compared to other central currencies has turned downward. For example, the euro rose back past the dollar in October–November, and one euro has fetched around $1.06 this week.

The dollar index has fallen from its peak in September by more than eight percent, and Bloomberg’s Dollar Spot index by about 7.5 percent.

Many experts believe that the dollar’s heyday is over, and the rate of the world’s leading currency will develop weakly even for years.

“We believe the dollar has peaked and that a multi-year downtrend has begun,” says the head of emerging markets research at Singapore-based BNP Paribas Siddharth Mathur for the news agency Bloomberg.

Signs the weakening of the dollar – and on the other hand the reasons for it – can be found in different parts of the world.

The strengthening of the dollar last year was driven in particular by the US central bank Fed’s exceptionally fast pace of rate hikes and the general uncertainty of the market.

When the Fed significantly tightened monetary policy and interest rates rose in the United States, it attracted investors to move their wealth to the United States, attracted by better interest rates than before. This, in turn, increased the demand for the dollar even more.

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The Fed tightened its monetary policy last year more drastically than many other central banks.

This year, however, the Fed has slowed down the pace of raising the key interest rate, and the market is already speculating about when the central bank will decide to turn the key interest rate down.

At the same time, central banks elsewhere have continued to tighten monetary policy, thus tightening the Fed’s “lead”. For example, the European Central Bank, the ECB, is expected to raise its deposit rate to 3.75 percent by the fall, i.e. a historically high rate.

Read more: The final inflation data for the euro area support the continuation of the ECB’s interest rate hikes

Second a significant reason for the strong development of the dollar last year was the general uncertainty of global markets. The energy crisis caused by Russia’s war of aggression ravaged Europe and China’s strict corona lockdowns messed up the structures of the world economy.

High inflation and the interest rate hikes to curb it weakened market sentiment even more.

When the market situation was unstable, investors started to avoid high-risk investments. Fearing other investment options, investors took their funds to the safe haven, the stable dollar.

Now investors’ fears have started to ease, at least to some extent. One sign of this is the strong cash flow to emerging market investments at the beginning of the year. Developing economies also benefit from a weaker dollar as their import costs decrease. This, in turn, would help curb the global inflation rate.

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Read more: FT: Investors are pouring money into emerging markets at an almost record pace

Some institutional investors have already bet on the dollar weakening. However, according to Bloomberg, few believe that the value of the dollar will collapse in the near future.

“The dollar has reached its peak, but we don’t think the strong development of the last two years will be completely reversed,” says the Asian fixed income investment director of the Singapore-based company Pinebridge Investments to Bloomberg Omar Slim.

“The peak has been seen, but the dollar will remain supported because it is still considered a safe haven,” says Deutsche Bank’s Asia-Pacific chief investment officer to Bloomberg Stefanie Holtze-Jen.

in Finland Nordea’s economists they were born on Thursdaythat in the coming months the dollar will strengthen even more compared to the euro, when the Fed will have to raise the key interest rate even more than expected.

However, they believe that in the second half of the year, the euro and the other major benchmark currencies of the dollar will strengthen against the dollar, when the central bank’s interest rate hikes will end.

However, Nordea’s economists remind us that higher-than-expected interest rates increase the risk of a recession. And thus it is also possible that the US dollar will strengthen again surprisingly soon.

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