The US Dollar is gaining strength primarily because there is a high demand for it currently in the market. The economies of most nations in the world are experiencing a slowdown, and the ongoing war in Ukraine has given rise to a significant geopolitical risk. The volatility in the global markets is high, and to top it all, the rising inflation has prompted the Federal Reserve in the USA to hike interest rates aggressively.
Kavan Choksi- prompting a flight to economic safety
According to eminent business and financial expert Kavan Choksi, the above factors, along with others in the global market, are prompting investors in the market to exit their positions in emerging markets, Europe, and other places. They are looking for a safe harbor in assets that are the US denominated so that they can use dollars to make their purchases. If you compare the dollar to a basket of currencies, it has gained value by almost 14% since last year at the same time.
This is not new for the US dollar, as the Ukraine-Russian War has generated an initial appreciation of the dollar against currencies of the emerging markets that were higher in preferences linked to the 2013 tapering policy, along with events that involved oil exporters in the past.
The dollar continues to appreciate
The global market is expected to witness a continuous increase in the Fed rate. In the past, the same situation of the rapid rise of the Fed rate led to emerging markets facing a lot of crises. For instance, in the 1980s, the Lost Decade occurred in Latin America, and later in the 1990s, the Tequila crisis emerged in Mexico, and it later extended to East Asia and Russia.
Central banks and their impact
With the US Federal Reserve hiking the rates of interest, the Central Banks should increase their rates individually to stay competitive in the market and to defend their local currencies. This means that investors should be given a reason for getting higher returns for investing in an emerging market over moving their money into US assets that are less risky in nature.
The above scenario presents the world with a conundrum. This means that the central bank wishes to protect foreign investments in the domestic market, but on the other hand, the hike in the rates of interest triggers domestic borrowing. The above phenomenon will have a dampened effect on economic wealth as well.
According to business and finance expert Kavan Choksi, the US dollar has grown by about 11% since the beginning of the year. In the last 20 years, this is the first time that it is reaching parity with the Euro in the world.
At the same time, it has been seen that a large number of global currencies have depreciated against the USD, and the above trend is going to have a significant impact on the developing nations of the world. In order to prevent any financial crisis, governments have reduced options to arrest financial problems in the short term; however, they should focus on their fiscal position and engage more in actions related to sustainable borrowing.