The greenback’s rise siphons global investment
The frontline in the global war against inflation runs through the US Federal Reserve headquarters in Washington. After a hesitant start, US monetary policymakers are making up for lost time with policy rates on a runway from near-zero during the pandemic toward nearly 3 percent by the end of the year. Other central banks are following similar upward paths, but look unlikely to match the pace of tightening in the US.
The consequence is a growing interest rate differential that drives the rise of the dollar against other major currencies. The contrast is particularly striking in Japan where a very loose monetary policy stance has driven a sharp depreciation in the yen. But the gap is also widening with the euro.
The European Central Bank is concerned about the repercussions of a military conflict on its eastern flank and risks pertaining to energy trade with Russia, and is toeing a more cautious line than the Fed. Some analysts now speculate that the euro might fall to parity with the dollar this year.
While some of the early leaders on the monetary tightening path, such as the Bank of England, seem to be edging toward a much more cautious stance, the US central bank has so far stuck to its guns. Fed chair Jerome Powell earlier this month openly acknowledged that taming inflation to the Fed’s 2 percent target — from its March peak of 8.5 percent, which declined only marginally to 8.3 percent in April — will cause “some pain.”
The dynamics of the dollar matter a great deal for the Gulf countries, which all peg their currencies to the greenback. The Kuwaiti dinar is the sole — partial — exception since it follows a heavily dollar-dominated basket.
While recurrent periods of divergence between the economic conditions of Gulf Cooperation Council nations and the US have periodically fueled debates about the need for increased exchange rate flexibility, this now increasingly looks like a period when the dollar peg will serve Gulf countries quite well.
Moreover, GCC economies are experiencing a robust recovery. This pickup in growth shows every sign of developing further momentum because of a combination of factors. The OPEC+ policy of gradually increasing crude output will mean strong expansion in the oil sector, all the more since a lion’s share of the world’s spare capacity is in the GCC.
The non-oil growth outlook remains strong as economic activity and international travel normalize. But a strong dollar complicates the global economic outlook in other ways.
By pushing up the valuation of US assets at a time when rates are also increasing, they allow investors to achieve acceptable returns by taking on less risk. This curbs the appeal of high-yield securities as well as emerging economies.
In an environment where many investors will return to the comfort zone of US assets, safeguarding and further enhancing the appeal of the Gulf through proactive steps will matter that much more. But such steps hold value not just in the short term, but also for the broader economic paradigm shift of more open markets that the region is pursuing. Investor appeal that is built on more than just the oil cycle or exchange rate dynamics is what long-term prosperity can be built on.
A strong dollar is part of why you’re seeing very limited investment in emerging markets today. Why is this here?