A dollar that's too strong for the world

A dollar that's too strong for the world
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KUALA LUMPUR (May 21): The US dollar has been strengthening over the last couple of months since the Federal Reserve started raising its federal fund rate by 25 basis points during its March 2022 meeting, to tame wild inflation in the world’s largest economy.

The US Dollar Index (DXY), an index that tracks the movements of the greenback against a basket of major currencies including the British pound, euro, yen, Swiss franc and Canadian dollar, was hovering around 96 points in December 2021.

At the time, talks of rate normalisations by Fed chair as well as the Federal Open Market Committee (FOMC) voting members were already well on the way, as inflation swung to the highest level in more than 30 years in the US.

The index, which started in 1973 after the collapse of the Bretton Woods standard that saw the US dollar no longer backed by Fed’s gold reserves, went on to breach 100 points in the middle of April following the first rate hike a month earlier.

By the middle of this month, the DXY had pushed towards 105 points, a level not seen since late 2002. In short, the US dollar today is at its strongest point in 20 years. And this could have a fundamental impact on the global economy.

And the Fed is not yet done with its rate normalisation. Its chair Jerome Powell has said the Fed will continue to increase rates, as long as it does not see that its monetary policy has had an impact on taming consumer price increases in the US.

With the rising interest rates in the US, investors will find it more attractive to hold US assets.

Already, many emerging market currencies have depreciated against the greenback. Besides the ringgit, which has depreciated against the US dollar by 5.2% so far this year, other regional currencies have suffered the same fate.

The Singapore dollar has depreciated 2.3% year-to-date against the greenback, while the rupiah has declined 2.68%. The baht is down 3.37% so far this year, while the Philippine peso has lost 2.27% of its value against the greenback.

Can the world, especially emerging markets, withstand the outflow of funds as the Fed’s fund rate keeps on increasing? Which emerging market countries will be the most at risk as hot money flow out of their assets to find better yields in the US?

Are the situations today similar to past periods when the hawks among the Fed’s Board of Governors and FOMC pushed through their agenda of rising interest rates fast and in big quantums, as seen in the early 80s and late 90s?

In an accompanying story, we also take a look at how investors should strategise their investment portfolio amid the weakening of regional currencies. Investment experts opined that Southeast Asia will maintain its position as a preferred choice of investment in view of its tremendous economic potential, despite the aggressive US rate hikes and strong US dollar.

In the past, Asean markets saw mixed reactions to the strengthening of the greenback. How will they react this round?

Read more about it in the May 23 issue of The Edge Malaysia weekly.

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