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As any old-school currencies trader will tell you: buy dollars, wear diamonds. It is certainly shaping up to be a decent bet this year, in a manner that is throwing up pockets of stress around the world. But if you are waiting for a shock-and-awe exercise to turn this around, you are likely to be waiting a long time.
At a glance, the world’s dominant reserve currency is pretty dull at the moment. The DXY dollar index, which tracks it against a clutch of other major currencies, is up 4 per cent or so in 2024 — a decent ascent but nothing spectacular. The index still sits about 7 per cent below the record high it struck in September 2022.
But to many analysts and investors, that just gives the buck space to keep stretching higher as markets recalibrate their US interest rate expectations. “The dollar still has more to give,” wrote Shahab Jalinoos and Vassili Serebriakov, currency analysts at UBS. Some strain is already spilling over in Asia and emerging markets, and it is not too hard to imagine it becoming a source of broader market volatility later this year.
The reason for all this, of course, is that while the US still seems likely-ish to cut interest rates this year, that will not be until September at the earliest. And the Federal Reserve is expected to move once, twice at a pinch, whereas other major developed market central banks are on track for cuts much sooner or, in the case of Japan, stuck on a loose setting. That gap is a classic recipe for dollar strength. In late April, Goldman Sachs said it expected the dollar to be “stronger for longer”, with some “disruptive” elements. The best hope for turning that around is a continuation of Friday’s disappointing US employment data.
The exchange rate against the Japanese yen is right now the point of greatest tension, as evidenced by what looks an awful lot like an official intervention by the country’s authorities this week. The yen has been sliding pretty consistently now since early 2022. It has lost a third of its value since that time, leaving the dollar trading at highs not seen since the mid-1980s. But the latest lurch in which the yen breached ¥160 to the dollar was followed by a rapid recovery.
We will not know for sure whether this reflected dollar selling by the Bank of Japan until data on reserves is released in coming weeks, but market participants have little doubt this is the source. In any case, it didn’t really work. Unilateral interventions rarely do. The dollar did pull back to around ¥155, so this is something of a speed bump. But that’s all. If anything, analysts pencilled in higher, not lower targets for the dollar against the yen after this week’s shake-up.
“This is what happens when a central bank is on a completely inappropriate monetary policy setting,” said Peter Fitzgerald, chief investment officer for multi-asset and macro at Aviva Investors (for the avoidance of doubt, he is referring to the BoJ’s interest rate of zero per cent, not the US Federal Reserve’s, of a little over 5 per cent).
“The pressure valve is the currency, and the only way to address it is with monetary policy,” said Fitzgerald. Intervention, assuming that is what has taken place, will not move the dial, he adds.
Japan is not alone here. It expressed concern to US Treasury secretary Janet Yellen about the matter last month, along with South Korea. Also in late April, Indonesia’s central bank surprised market participants by raising interest rates in an effort to prop up the rupiah.
Currency weakness outside the US is not straightforwardly bad. It can, for example, help exports. Ironically, Japan spent years in the past two decades trying to push the yen down, not up. But one-way traffic and rapid declines are more unsettling, and can generate inflation by bumping up the cost of imported goods.
Europe could be heading for this treatment. Already, the euro is hovering around its weakest levels in two decades, at $1.07, due largely to that gap in interest rate profiles. But Barclays is among those warning that steeper declines may lie ahead. A second presidency for Donald Trump involving new trade tariffs could push the exchange rate down towards parity, it argues.
At that point, the calls for major authorities to band together and weaken the dollar would almost certainly grow louder. Indeed, in his last stint in the presidency, Trump himself was a vocal opponent of euro weakness. But for now, these all remain hypothetical risks. Analysts at UBS say the bar for late 1980s-style multilateral intervention — the only type that works — remains “very high”. A co-ordinated intervention was “not completely out of the question”, the bank wrote, but it would require much more pronounced dollar strength and market volatility. It might need “a new external shock sufficiently pressing and all-encompassing to make otherwise controversial co-ordination of domestic policies a palatable option”.
It is hard to argue that the US has an urgent need to cut interest rates. Until all of that changes, countries feeling the strain will be shouting into the void.
