By CHRIS ILLING
It has been a few busy weeks in the Forex (foreign exchange) markets. On Thursday, the reaction of the markets was unequivocal, and we saw a certain ruthlessness when UK prime minister, Liz Truss, had barely announced her resignation before the pound sterling was appreciating again. The 30-year UK government bond yield fell nine basis points, which means investors are now viewing those securities as less risky once again.
Across the Atlantic, US president Joe Biden has dismissed warnings of a strong dollar, and instead blamed poor economic policies and weak growth in other parts of the world for the weakening of the global economy. He was not worried about the strong dollar but about the rest of the world. The US economy is strong. With this sharp rhetoric, Biden is reacting to international criticism that was bundled at the annual meeting of the International Monetary Fund (IMF) and World Bank the previous week.
Rarely in the past 20 years has the US dollar been as valuable as it is now. Since January this year, it has gained 22 percent against the Japanese yen, 13 percent against the euro and around 6 percent against emerging market currencies. A strong dollar puts a strain on countries and their economies that have taken on large debts in US currency, or depend on raw material imports because these usually must be paid in dollars.
The strength of the dollar can be explained by the US Federal Reserve’s tight monetary policy. It has acted more resolutely than other central banks in raising interest rates, which in turn has made the dollar more attractive.
The war in the Ukraine is the second factor. It has pushed up commodity prices, especially food and energy. This development weighs particularly heavily on the euro area, has a mixed impact on emerging markets and is even positive overall for the US. At least part of the shift in currency relations can be explained by the fact that economic strength has changed. Europe is suffering more than the US.
Emerging countries have been doing surprisingly well so far. On the one hand, the central banks of many emerging countries have reacted particularly rigorously to inflationary tendencies, and thus also shielded the value of their currencies. Some central banks have also intervened in currency markets to support their currencies. On the other hand, some countries benefit from the development of raw material prices. These include Brazil, whose currency has appreciated against the dollar since the beginning of the year. Brazil is a major exporter of soybeans, iron ore and crude oil. Mexico’s currency is also still robust thanks to the development of crude oil prices.
But the strong dollar weighs heavily on emerging and developing countries because of higher import dependency, and because many bills must be paid in US dollars. They have also accumulated large debts due to the pandemic, many of which are also in dollars. There are now correlations with the early 1980s when Fed chairman, Paul Volcker, managed to curb inflation in the US. Monetary policy, together with President Ronald Reagan’s fiscal policy, had boosted the dollar to unprecedented heights. However, that was linked to a severe debt crisis in developing countries. Countries such as Egypt, Tunisia and Lebanon are very fragile.
The voices warning about a looming global recession are getting louder, and include now signals from billionaires Elon Musk and Jeff Bezos that tough times are ahead. Interesting times for the avid forex investor.
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