USD may continue to strengthen in 2023
Recession fears could push the dollar higher in 2023, after it has gained about 10% this year against a basket of major currencies.
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 the main 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 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.
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| 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 actively traded asset in the market for five straight months through November. Many respondents said the greenback is overvalued.
A separate Reuters survey of 66 foreign exchange strategists found the dollar is likely to trade at current levels for a year, with many predicting that tightening policy 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 profits 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 that convert foreign currencies into dollars. Technology and materials companies in the S&P 500 index have been hit 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 S&P 500 earnings by 8%, 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 dollar-denominated commodities, as it makes them more expensive for foreign buyers. It also makes it more expensive for foreign companies and governments that borrow in dollars to repay.
And while a strong dollar may curb US inflation, it also pushes other currencies down, 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 contributed to a 5% drop in the greenback against a basket of major currencies in November, its biggest decline since 2010.
Whether the decline in the USD can be sustained or not may depend on the Fed's ability to control inflation. Last week, US inflation cooled down in November, when the CPI increased by only 7.1% compared to the same period last year, down from 7.7% in October. This caused the Fed on December 14 to slow down the rate hike compared to previous times, with 50 basis points (0.5%).
In the longer term, economic concerns could be a factor driving the dollar’s direction, with nearly 80% of strategists surveyed by Reuters saying monetary policy is unlikely to push the greenback higher next year.
