Dollar’s rising strength raises global alarm

The strengthening of the US dollar has emerged as a significant concern for countries worldwide, triggering alarm bells not only in emerging economies (EMs) but also in advanced industrialised countries.

The currencies of the G20 group of major economies are almost all depreciating against the dollar. The Turkish lira has been leading the decline since the beginning of the year at 8.8%; the yen has fallen 8% and the South Korean won 5.5%.

Both developed and emerging economies have seen currencies weaken at an accelerating pace, with the Australian dollar, Canadian dollar, and euro falling 4.4%, 3.3%, and 2.8%, respectively.

Why is the US dollar appreciating?

The primary impetus behind the dollar’s rally is the receding prospect that the US Federal Reserve will soon cut interest rates. The US consumer price index (CPI) released Wednesday (April 10) rose by more than market expectations, meaning higher US inflation might be returning.

Consequently, traders have scaled back their bets on potential Fed interest-rate cuts, thereby propelling the dollar’s ascent. Reflecting this trend, the Bloomberg Dollar Spot Index, tracking the greenback against a basket of major currencies, has surged by over 4% this year alone.

US Federal Reserve Cairman Jerome Powell explaining the central banks interest-rate policy US Federal Reserve Cairman Jerome Powell explaining the central banks interest-rate policy.

In addition, growing tensions in the Middle East following Iran’s attacks on Israel have boosted the US currency more recently thanks to its safe-haven status.

Finally, while many economies worldwide are experiencing moderate growth, US economic indicators, ranging from employment figures to retail sales, are consistently outpacing expectations.

While several emerging economies still offer higher yields on their bonds than US debt, the gap has been shrinking. At the start of last year, Brazil’s policy rate was 13.75%, Chile’s was 11.25% and Hungary’s was 13%. Since then, central banks in the three economies have trimmed their key rates, narrowing the yield advantage for potential investors.

Emerging economies particularly exposed

Developing countries are particularly sensitive to the negative effect of the dollar’s rise, as a surge in the value of the greenback drives up interest on their dollardenominated debt, increasing their interest burden.

According to the International Monetary Fund (IMF), a 10% rise in the dollar on the currency market would push down real gross domestic product (GDP) in emerging economies by 1.9% after one year, with adverse economic effects lasting more than two years.

In 2022, when a similar dollar strengthening was underway, Sri Lanka fell effectively into default as its currency depreciated. Other emerging economies tried to prevent their currencies from depreciating by raising interest rates ahead of the US Fed in 2021 and 2022.

At the beginning of 2024, many believed that US interest rates would be lowered by the end of the year and that the dollar’s strength would be corrected. But now the dollar may be on track for a longer-than-expected rally.

Emerging markets already in crisis mode

Several emerging-market countries have already begun to take action. Brazil’s central bank, on April 1, intervened in the foreign exchange market for the first time since President Luiz Inacio Lula da Silva took office at the beginning of last year. Although the government and the central bank have not clearly explained their intentions, some in the market believe that the purpose was to check the depreciation of the real.

Bank Indonesia (BI) has been stepping in to shore up the rupiah, which is at a four-year low, hovering around the level of 16,000 rupiah to the dollar. BI Governor Perry Warjiyo told reporters after attending a meeting with President Joko Widodo on Tuesday, that the central bank is “always in the market and will ensure the currency is stable.”

Turkey’s central bank also raised its policy rate by 5 per cent to 50 per cent in March in response to the lira’s depreciation and accelerating inflation.

However, developing countries also fear a situation where their economies cool down due to interest-rate hikes to curb inflation, as in Turkey.