Dollar Strength Bucks Inflation Calamity

Years ago, high US inflation meant a weak dollar. So far, this time has been different, and many on Wall Street are betting it will stay that way.

The dollar is hitting multiples high against its trading counterparts, even with US inflation is at its highest level for almost 40 years. The US Dollar Index, which tracks currencies against a basket of other currencies, is hitting a high not seen since 2002. The greenback’s escalation sent the euro, pound and Japanese yen plunging.

It’s a different story from the one that took place during the 1970s inflation crisis. Dollar down almost 40% against West Germany, then one of Europe’s most influential currencies, between January 1974 and 1980, according to Federal Reserve Bank of St. Louis. Federal Reserve Chairman Paul Volcker in 1979 began sharply raising interest rates, spurring a strong recovery.

Investors say economic weakness around the world is driving the strong dollar today. The Covid-19 shutdown in China has slowed industrial production in the region, and war between Ukraine and Russia is driving up energy costs for European households, which depend on Russia for natural gas, and around the world. The economy of the euro area must face threat of a recession.

The picture in America is different. Consumers have more money in the bank account. Even if prices go up, Americans are spending. The data shows businesses pouring money into equipment and research and development. Fed Chairman Jerome Powell expressed confidence that the economy can weather a series of challenges interest rate increase at the Fed’s policy meeting on Wednesday.

This week, traders will be analyzing consumer spending data and Friday’s monthly jobs report for clues regarding the health of the economy and the trajectory of the stock market. . US stocks fell sharply on Thursday, delete profits from the previous session.

Chris McReynolds, head of inflation trading at Barclays and formerly a forex trader, says the dollar is outperforming other currencies because of bad inflation and growth prospects in other countries. than. The US Dollar Index is up 14% over the past year.

“The US economy is much less vulnerable than other economies,” Mr. McReynolds said.

Rick Rieder, director of bonds and fixed income at BlackRock, said he is buying the dollar and selling currencies hit by weaker economic growth against the US, including the euro, Chinese offshore yuan and a small amount of the yen.

The currency derivatives markets show that investors expect the dollar to continue to outperform. Traders at banks say customers are buying call options if the dollar continues to rise: Calls on the dollar against the yen have become more expensive than trading in October 3, a reversal in a metric that traders use to gauge demand for the dollar.

A strong dollar allows Americans to buy goods from other countries at lower prices. But it can also hurt U.S. manufacturers by making products more expensive for foreigners, and that means U.S. businesses get fewer dollars for exports. their.

Microsoft Corp.

said in its earnings report earlier this month that a stronger dollar dented the software company’s revenue, even though it higher profit recognition previous quarter.

During the 1970s, inflation and 1973 Arab oil embargo pull the greenback down. Europe today is grappling with shortages in energy supplies and growth concerns, potentially leading to a phenomenon known as stagnant inflation, marked by rising prices and a slower pace of growth. growth slows, which often causes investors to sell off a currency. The euro has depreciated nearly 13% against the dollar over the course of the past year.

Stephen Gallo, head of European foreign exchange strategy at BMO Capital Markets, said investors’ perception of how central banks will act should boost the dollar. The European Central Bank is yet to raise interest rates, with President Christine Lagarde saying earlier this month it will lag behind the Fed in tightening monetary policy. Bank of Japan also recently reinforce its commitment Low interest rates.

Interest rate derivatives show Investors expect the Fed to raise the benchmark federal funds rate from the current level of 0.75% to 1% to just over 3% next year.

“Central banks that are more reliable in targeting inflation will attract most of the cash flows,” said Nafez Zouk, an analyst at Aviva Investors. “The Fed has finally signaled that it is taking inflation seriously.”

Another reason for dollar dominance: the consistent outperformance of US assets over European assets. One measure of this can be found in global equities: Over the past decade, equities in the US have provided investors with superior returns, while their European counterparts have remained below and mostly range fluctuations. The S&P 500 Index in December is up more than 400 percent since 2009, compared with a 137% gain for the Stoxx Europe 600 in the same period.

Keith Decarlucci, Chief Investment Officer of London-based hedge fund Melqart KEAL Capital who has traded money markets for more than 30 years, said the dollar’s position as a haven amid uncertainty Geopolitics and its role as the world’s reserve currency put it in a stronger position today than it did in the 1970s, when the United States imported more oil and give up the gold standard.

But Morgan Stanley and Barclays predict it will fall this year. Strategists say the currency will not be as attractive as economic growth in Europe or if inflation in the US rises above 3%.

Write to Julia-Ambra Verlaine at [email protected]


What do you think explains the strength of the dollar? Join the conversation below.

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