The strength of the dollar pushes the world economy into a deeper slowdown

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(Bloomberg) — The rising dollar is pushing the global economy into a synchronized slowdown by raising borrowing costs and stoking financial market volatility, and there is little respite on the horizon.

A closely watched gauge of the dollar has risen 7% since January to a two-year high as the Federal Reserve embarks on an aggressive series of interest rate hikes to rein in inflation and investors have bought dollars as a haven in amid economic uncertainty.

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A rising currency should help the Federal Reserve cool prices and support American demand for goods from abroad, but it also threatens to raise foreign economies’ import prices, further raising their inflation rates and taking away from them. capital.

That’s especially worrying for emerging economies, which are forced to allow their currencies to weaken, intervene to cushion their decline, or raise their own interest rates in a bid to bolster their currency levels.

Both India and Malaysia surprised by raising rates this month. India also entered the market to prop up its exchange rate.

Advanced economies have not been spared either: Last week, the euro hit a new five-year low, the Swiss franc weakened to parity with the dollar for the first time since 2019, and the Hong Kong Monetary Authority was forced to intervene to defend himself. its currency parity. The yen also recently hit a two-decade low.

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

While the combination of slowing US growth and expected cooling in US inflation will ultimately cause the dollar’s rise to slow, which in turn will remove pressure from other central banks to harden, it can take months to find that new balance.

At least so far, traders are reluctant to call a spike in the dollar’s rally. That partly reflects bets in late 2021 that the dollar’s gains would fade as rate hikes were already priced in. Since then, those opinions have been destroyed.

Developing economies are in danger of a “currency mismatch,” which occurs when governments, corporations, or financial institutions borrow in US dollars and lend in their local currency, according to Clay Lowery, a former US Undersecretary of the Treasury. US for international affairs. who is now Executive Vice President of the Institute of International Finance.

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Global growth will essentially stall this year as Europe slips into recession, China slows sharply and US financial conditions tighten significantly, according to a new IIF forecast. Morgan Stanley economists expect growth this year to be less than half the pace of 2021.

As rates continue to rise amid ongoing global volatility, from the war in Ukraine to China’s Covid lockdowns, that has prompted investors to seek safety. Economies with current account deficits are at risk of increased volatility.

“America has always been a safe haven,” Lowery said. “With interest rates rising from both the Fed and market rates, even more capital could flow into the US and that could be detrimental to emerging markets.”

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Outflows of $4 billion of securities from emerging economies were seen in April, according to the IIF. Emerging-market currencies have tumbled and emerging Asian bonds have suffered losses of 7% this year, more than the hit received during the 2013 tantrum.

“Tighter US monetary policy will have big effects on the rest of the world,” said Rob Subbaraman, director of global markets research at Nomura Holdings Inc. “The real catch is that most economies outside of the US . ourselves”.

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

Toyota Motor Corporation. forecast a 20% decline in operating profit for the current fiscal year despite posting strong annual car sales, citing an “unprecedented” rise in logistics and raw material costs. He said he doesn’t expect the weakening yen to provide a “major” boost.

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China’s yuan has fallen as record capital flows are withdrawn from the country’s financial markets. For now, it remains insulated from the broader dollar effect, as low domestic inflation allows policymakers to focus on supporting growth.

But that is causing another source of fragility for developing nations used to a strong yuan offering an anchor to their markets.

“The recent abrupt change in the renminbi’s trend has more to do with China’s deteriorating economic outlook than Fed policy,” said Alvin Tan, a strategist at the Royal Bank of Canada in Singapore. “But it has definitely chipped away at the shield that insulates Asian currencies from the rising dollar and precipitated the rapid weakening of Asian currencies as a group in the last month.”

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

The member of the Governing Council of the ECB, Francois Villeroy de Galhau, pointed out this month that “a euro that is too weak would go against 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 significantly above central banks’ 2% targets,” Perkins wrote. “Monetary tightening could alleviate this problem, but at the cost of further domestic economic pain.”

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