Dollar's Epic Rally Reverses Course, Further Losses Predicted

In 2022, the U.S. dollar experienced a surge in value, demonstrating its potential to cause disruption in the international economy. Investors are hopeful that the dollar's strength has reached its peak.

At the end of December, the WSJ Dollar Index, which tracks the dollar's value against sixteen other currencies, had risen 8.9% since the start of the year. This would be the largest yearly increase since 2014, with the index reaching its highest point since 2001 in late September.

The dollar has been on the decline since reaching its peak earlier this year, with investors believing that inflation in the United States is slowing. Roughly half of its gains have been lost.

Many investors were surprised by the US dollar's strength in 2021. The currency had already been increasing due to the anticipation that the Federal Reserve would raise interest rates to control the perceived short-term inflation. Some investors thought the dollar was too high and expected it to decrease.

It was a surprise to many that inflation remained so persistent, and that the Federal Reserve increased rates by more than 4 percent in a period of nine months. When rates go up, it encourages investors from all over the world to invest in U.S. assets such as Treasury bonds, which in turn strengthens the dollar. The invasion of Ukraine by Russia caused investors to seek out safer investments, and the rise in energy prices added to the inflationary pressures.

According to Derek Halpenny, head of research for global markets in the European region at Japan’s MUFG Bank, the invasion of Ukraine by Russia was a major factor in the decision to have a weak dollar in 2022. He stated that this event created a second global inflation shock that caused the Federal Reserve to take the action it did.

The appreciation of the US dollar has had a worldwide impact, causing other currencies to reach record lows. In July, the euro fell below the dollar's value, and the British pound dropped to its lowest rate in two centuries when compared to the dollar in September. Additionally, the Japanese yen experienced its weakest point since 1990.

Andrew Keirle, a global fixed-income portfolio manager at T. Rowe Price, compared the dollar to a vortex. He explained that as the dollar gains strength, the weaker assets are the first to be taken up. He went on to say that as the force of the dollar increases, even the better assets will start to be affected.

The fluctuations of the U.S. dollar have a global impact due to its status as the main currency for international commerce and finance. When the dollar rises, commodities like wheat and American products become more expensive for buyers outside of the United States, leading to inflation in other countries and a decrease in profits for U.S. companies that depend on foreign markets.

In certain less affluent countries, the appreciation of their currency has been catastrophic. Sri Lanka was in danger of running out of US dollars this year as it used up its stockpile of foreign currency reserves, which had already been reduced due to the pandemic, to purchase essential items such as fuel and food.

Eswar Prasad, a trade policy professor at Cornell University, noted that while the major emerging markets did not experience a crisis, there is a more subtle crisis that has affected many parts of the world, particularly those with low-income economies. He pointed out that the increase in food and commodity prices, which are usually denominated in U.S. dollars, has been a major blow to these economies.

The appreciation of the U.S. dollar has caused debt issues in certain developing countries. Ghana is the most recent nation to begin the process of restructuring its debt after a sharp decline in its currency caused the cost of repaying its foreign-currency debts to increase.

Investors are optimistic that the dollar has reached its highest point. Stephen Jen, the head of the hedge fund Eurizon SLJ Capital, believes that the dollar will drop 10-15% in the upcoming year due to a decrease in U.S. inflation and a shift in focus to the structural issues of the U.S. economy, such as its high debt.

Steve Englander of Standard Chartered believes that the value of the dollar will decrease as the economic outlook of other countries improves. He anticipates that China's reopening will have a positive effect on economies abroad, and that worries about Europe's energy supply will diminish over the course of the year.

Mr. Englander, the head of foreign-exchange research for the G-10, or Group of Ten nations, at the bank, predicted that the first quarter would bring clarity to the situation and be beneficial for the dollar. However, he cautioned that there would be a lot of ups and downs until the picture became clearer.

JPMorgan Chase & Co. analysts are not as quick to predict the end of the dollar's strength and anticipate that it will increase by an additional 5% against major trading partners in the upcoming year. They think that the demand for dollars will stay strong as central banks keep tightening their policies and the possibility of a recession increases.

The outlook for economies with low incomes that have been most affected by the appreciation of the dollar and the increase in borrowing costs is still grim. Many of these countries have used up their foreign exchange reserves in the current year and are unable to access international loan markets.

Mr. Prasad of Cornell commented that if the Federal Reserve were to halt their rate increases and the dollar continued to depreciate, it would reduce the strain on low-income economies. However, he noted that many of these countries are already facing serious issues with financing imports and external financing, so it will be a difficult year for them regardless.