Last week the U.S. Dollar Index, which measures the U.S. currency against a basket of six peers including the euro and pound, rose to 114.75. It has slipped back a little since then, but is still at its strongest since early 2002 after gaining 20% this year.
The strong dollar coupled with global inflation, rising interest rates, and supply chain issues related to COVID-19 lockdowns in China are among the headwinds facing some companies and making investors nervous.
“There are several factors driving the dollar to gain strength against other currencies,” said AJ Shrestha, an economics expert on SAP’s Corporate Development team.
“The U.S. Federal Reserve has raised interest rates aggressively in a bid to bring down soaring inflation,” he noted. “The rising interest rates make the dollar more attractive to investors by guaranteeing a better return, so investors globally have recently been buying billions of dollars of U.S. bonds and the extra demand has pushed up the dollar’s value while dropping the value of other currencies sold to buy dollars.”
The dollar also has a reputation of providing a safe haven in times of economic distress. Higher energy and food prices, especially in the eurozone, have fueled recession worries and prompted investors to take refuge in the relative safety of the U.S. dollar, which is less exposed to some of the larger macro headwinds.
This flight to safety is driving the dollar’s value higher at the same time that several other currencies — including the British pound, the euro and Chinese renminbi — have come under pressure. The pound fell sharply after the new government rolled out a package of tax cuts, stoking investor fears about a burgeoning deficit, and the euro decline reflects concerns about energy supplies and inflation while the renminbi has fallen because of concerns about China’s slowing domestic economy.
“The Chinese economy has been depressed by a precarious real estate sector and disruptions from the country’s continuing zero-COVID policies,” said Shrestha. “In order to stimulate the economy, the Chinese central bank cut key interest rates, which is a very different path from what the U.S. is taking in response to economic issues at home.”
That divergence in policies should result in the dollar-renminbi exchange rate moving higher as the renminbi continues to weaken. A weaker renminbi helps make China’s exports more competitive in overseas markets, particularly the U.S., increasing demand. The lower prices for China’s manufactured goods should help reduce persistently high inflation in the U.S., benefiting American consumers.
Who are the other winners and losers from a strong dollar?
“Typically, a weak currency is seen as good news for export-heavy economies and bad for economies that rely on imports. So as the dollar strengthens, this is causing problems for developing nations, which depend heavily on imports of crude and other commodities that are priced in dollars and have become expensive in local currencies terms,” said Shrestha.
A strong dollar pushes import prices up, creating inflation in those regions and causing central banks to pursue an even more aggressive monetary policy stance in order to reduce demand, which in turn raises local borrowing costs.
For emerging economies with a large amount of dollar-denominated debt, a strong dollar is especially troubling. A strong dollar could make the cost of servicing this debt unsustainable in some of those countries, resulting in defaults — a risk highlighted this week in a report from the United Nations Conference on Trade and Development (UNCTAD). Furthermore, with rising rates in the U.S. and the dollar climbing, money will start to flow out of those countries, resulting in less investment.
Large U.S. corporations that operate in multiple countries could also be hurt because they become less competitive in overseas markets and their foreign sales lose value when converted back into dollars. U.S. workers in industries that are export-heavy, like agriculture or manufacturing, could also be impacted negatively.
But SAP CEO Christian Klein says the European software giant is an exception to that rule.