Borrowing costs

The soaring US dollar is destroying the global economy by driving up borrowing costs and fueling financial market volatility

Advanced economies were not spared either. Last week, the euro hit its lowest level in five years, the Swiss franc weakened to parity with the dollar for the first time since 2019, and the Hong Kong Monetary Authority was forced to to intervene to defend its monetary peg. The yen also recently hit a two-decade low.

“The rapid pace of Fed rate hikes is causing headaches for many other economies…triggering portfolio outflows and currency weakness,” said Tuuli McCully, head of Asia-Pacific economics at the Bank. Scotia.

While the combination of slowing US growth and an expected slower US inflation will ultimately slow the dollar’s ascent – ​​which in turn will reduce the pressure on other central banks to tighten – it may take months to find this new balance.

Currency mismatch

So far at least, traders are hesitant to call a spike in the dollar rally. This partly reflects bets at the end of 2021 that the greenback’s gains would fade as rate hikes were already priced in. These opinions have since been shredded.

According to Clay Lowery, former U.S. Assistant Secretary of the Treasury for International Affairs, developing economies are threatened by a “currency mismatch,” which occurs when governments, corporations, or financial institutions have borrowed in U.S. dollars and lent in their local currency. is now Executive Vice President of the Institute for International Finance.

Global growth will essentially stagnate this year as Europe slips into recession, China slows sharply and financial conditions in the United States tighten significantly, according to the IIF.

Morgan Stanley economists expect growth this year to be half that of 2021.

As rates continue to rise amid continued global volatility — from war in Ukraine to COVID-19 lockdowns in China — it has led investors to rush for safety. Economies with current account deficits are likely to be more volatile.

“The United States has always been a safe haven,” Lowery said. “With the Fed and market rates rising, even more capital could flow into the United States, which could hurt emerging markets.”

Leaving in a weak position

Outflows of $4 billion ($5.8 billion) were recorded from emerging market securities in April, according to the IIF. Emerging market currencies have fallen and emerging Asian bonds have suffered losses of 7% this year, more than the hit suffered in the 2013 crisis.

“The tightening of US monetary policy will have significant spillovers to the rest of the world,” said Rob Subbaraman, head of global markets research at Nomura Holdings.

“The real boost is that most economies outside of the United States are starting in a weaker position than the United States itself.”

Many manufacturers say the high costs they face mean they don’t get much dividend from weaker currencies.

Toyota forecast a 20% drop in operating profit for the current fiscal year despite robust annual car sales, citing an unprecedented rise in logistics and raw material costs. He said he doesn’t expect the weakened yen to provide a major boost.

The Chinese yuan fell as record inflows of capital withdrew from the country’s financial markets. For now, it remains shielded from the broader dollar effect as low inflation in the country allows authorities to focus on supporting growth.

But this creates a new source of fragility for developing countries accustomed to a strong yuan providing an anchor for their markets.

“The renminbi’s recent abrupt change in trend has more to do with China’s deteriorating economic outlook than with Fed policy,” said Alvin Tan, strategist at Royal Bank of Canada in Singapore.

“But it definitely broke the shield insulating Asian currencies from the rising dollar and precipitated the rapid weakening of Asian currencies as a group over the past month.”

In advanced economies, weakening currencies have created a “tricky political dilemma” for the Bank of Japan, the European Central Bank and the Bank of England, wrote Dario Perkins, chief European economist at TS Lombard in London, in a recent note.

Francois Villeroy de Galhau, a member of the ECB’s Governing Council, noted this month that “too weak a euro would run counter to our objective of price stability”.

“While domestic overheating is primarily a US phenomenon, weaker exchange rates are adding to pressures on imported prices, keeping inflation well above central bank targets of 2%,” Mr. Perkins.

“Monetary tightening could alleviate this problem, but at the cost of further domestic economic difficulties.”