Currency wars?

Pressures on exchange rates are emerging across the global economy as central banks move at different speeds in changing policy rates.

The US dollar index (the DXY) has been at levels not seen since 2002, with many major currencies sitting at low levels against the USD.  USD strength is likely to persist because inflationary pressures are proving persistent in the high pressure US economy.  The likelihood of material policy rate cuts by the Federal Reserve in 2024 has diminished rapidly.

The centrality of the USD in the global system (~90% of global payments and over 60% of official reserves) means that this will have meaningful economic and geopolitical spillovers. 

Our currency, your problem

For emerging markets, a high rates, high USD environment raises the risk of capital outflows and financial instability as well as pressures on borrowing costs.  And a strong USD acts a headwind to world trade growth because so much of world trade is invoiced in USD. 

Specific economies are being materially impacted.  For example, the euro and sterling are under downward pressure because the ECB and Bank of England are expected to cut policy rates more rapidly than the Federal Reserve.  Some are forecasting euro parity with the USD, which hasn’t been seen on a sustained basis since 2002.  This would make exports from European countries more competitive, but would make the disinflationary process more challenging.  And despite ECB denials, the changed Fed stance will likely slow the pace of rate cuts by the ECB to avoid rapid depreciation.

The pressures are even more acute elsewhere, notably in Asia.  Despite the Bank of Japan lifting the policy rate out of negative territory in March, the yen has depreciated by ~15% over the past year.  It fell to ~160 to the USD earlier this week, a 34-year low, before recovering to ~153 on Thursday (partly on official interventions in the market to support the currency).  Japanese officials are concerned because a weak JPY reduces the purchasing power of Japanese firms and citizens – and creates additional inflationary pressures.

The full note is available at: https://davidskilling.substack.com/p/currency-wars