USD could continue to strengthen in 2023

The dollar hit a 20-year high in September, rising 20% ​​against major currencies. That gain has now been halved, as investors bet the Federal Reserve would slow its rate hikes, which has been a major driver of the dollar’s ​​rise.

While rising interest rates were the main catalyst behind the dollar’s ​​rise, other factors also played a role in the dollar’s ​​rise. Investors rushed to buy dollars as a safe haven from market volatility caused by soaring global inflation, high energy prices and the Russia-Ukraine conflict.

Another reason is that the US economy is stronger compared to Europe, which is struggling with an energy crisis, and China, which is constrained by its Zero Covid policy.

The performance of the Dollar Index - which measures the strength of the USD against a basket of major currencies - this year. Chart:Reuters

Even after the rally has eased somewhat, the dollar is still on track for its strongest year since 2014. Fund managers surveyed by BoFA Global Research said the greenback was the most active trade in the market for five straight months through November. Many respondents said the dollar was overvalued.

A separate Reuters poll of 66 foreign exchange strategists found the dollar is likely to trade around current levels for a year, with many predicting that tightening by global central banks will further hurt growth, further boosting demand for the safe-haven greenback.

Keeping track of the US dollar’s ​​movements is key for investors, as it impacts everything from corporate earnings to the price of raw materials like gold and oil.

A strong dollar makes U.S. exports less competitive globally. It also hurts the profits of U.S. multinationals when they convert foreign currencies into dollars. Technology and materials companies in the S&P 500 index have been hit the hardest, Bank of America said.

Nike, IBM and Meta Platforms are among the companies that have warned of a hit to their businesses from the strong dollar this year. The dollar’s ​​strength has cut earnings by 8% for companies in the S&P 500 index, according to Tom Lee, director of research at Fundstrat Global Advisors.

For the rest of the world, a stronger dollar puts pressure on oil and other commodities priced in dollars, as it makes them more expensive for foreign buyers. It also makes it more expensive for foreign companies and governments to repay their debts in dollars.

And while a strong dollar may curb US inflation, it also pushes down other currencies, exacerbating the global inflation problem. In October, the International Monetary Fund (IMF) estimated that for every 10% appreciation in the dollar, global inflation would rise by 1%.

Still, there are signs that Wall Street sentiment toward the dollar may be changing. Data showing consumer prices fell less than expected in October helped push the greenback down 5% against a basket of major currencies in November, its biggest monthly decline since 2010.

Whether the dollar’s ​​decline can be sustained or not may depend on the Fed’s ability to contain inflation. Last week, US inflation cooled down in November, with the CPI rising only 7.1% year-on-year, down from 7.7% in October. This prompted the Fed on December 14 to slow down its rate hikes compared to previous times, by 50 basis points (0.5%).

In the longer term, economic concerns could be a driver of the dollar’s ​​direction, with nearly 80% of strategists polled by Reuters saying monetary policy is unlikely to push the greenback higher next year.