The value of the U.S. Dollar has been soaring since early November, just after the conclusion of the 2024 election that saw Donald Trump reelected and following a series of rate cuts by the Federal Reserve. Ordinarily, this reflects economic strength, but it can also have unintended consequences for American companies and the delicate balance of the currently volatile global economy.
With the potential of new policies from Trump as well as growing political tension, many investors and commercial banks are looking to central banks of major and emerging economies for their responses to the new strength of the dollar.
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Setting the Stage
Trump is going to be the 47th president of America and the U.S. dollar has been on a roll since he won the presidential election. Despite the fact that Trump claims to be in favor of a weaker dollar, traders and investors that use advanced tools on platforms like OANDA Prop Trader saw the greenback gain against all its major trading pairs. During this time, the dollar reached a two-year high, hitting the 108.00 mark last seen in 2022. However, it currently hovers around 106.00, potentially due to profit-taking.
Although the Federal Reserve Bank has been cutting interest rates since September, the interest rate differential is high when compared to other major economies, which some experts predict might be one cause of the dollar’s current rally. However, other factors, like the safe-haven status of the greenback and the escalation of the geopolitical conflict between Russia and Ukraine, cannot be overlooked as potential drivers of the current uptrend.
Amid all these, experts in the investment community believe that the dollar’s gain may be a reaction to the American and global markets bracing for the impact of Trump’s proposed tariffs on European and Chinese imports, which would most likely reignite inflation in America. Markets are also predicting that the Federal Reserve might not continue its current cycle of rate cuts given that inflation remains above the 2% target. This suspicion seems to be on track as the Feds, Jerome Powell, stated after the last meeting that the Reserve is not on any preset course nor in a hurry to cut rates. However, the markets are predicting a 53% chance of another rate cut in mid-December.
Impacts of a Strong Dollar
As the dollar stands, there’s a lot on the line, because while some people might enjoy it, others can be really hurt by it. American consumers, for example, currently have higher purchasing power with an increased ability to import goods and travel abroad because both are cheaper for them. It also means that multinationals doing business in the U.S. benefit by earning in a currency with more value.
However, “the strong dollar doesn’t float all boats.” U.S. exporters will find it difficult to remain competitive in the global market as their goods become more expensive for other countries to buy (import), which can have a negative impact on the economy. That means sectors like manufacturing, which are particularly exposed to global trade, may experience layoffs due to slowing economic activities, affecting the already steadying economy.
The value of the dollar is heavily dependent on and reflective of economic conditions within and outside the U.S., which means that, on a global scale, the increasing value of the dollar always has an impact, usually negative, on other economies. A strong dollar causes a huge jump in debt servicing for significantly indebted countries, and U.S. trade partners usually experience economic slowdowns. Japan and South Korea, for example, have begun expressing serious concerns about the downward trend of their currencies.
Central Banks’ Potential Strategies
Striking a balance between the strength of the dollar and its effect on different economies is difficult, but it is the goal. Right now, an overwhelming number of countries and companies use the U.S. dollar as the primary currency for their global trade of goods and services in an increasingly dominant world trading system. So, it is important for global financial bodies to implement strategies to maintain the global trading system’s delicate balance. Here are three strategies that different central banks might employ:
1. Adjusting Monetary Policy
Over the last few months, central banks around the world, particularly those in the basket of currencies in the UDX, have had little to no change in their interest rates, except the Bank Of Japan (BOJ), which only started raising rates after years of tight monetary policy (-0.1% interest rate in March). However, the BOJ governor, Kazuo Ueda, pointed out that the bank will continue to raise interest rates as long as the economy improves as expected. This, in itself, is a good move that can help battle inflation in the country while also assisting in strengthening the Yen against the dollar. Other central banks, like the European Central Bank, the Bank of England, and the Reserve Bank of Australia, are easing or maintaining policy rates, taking a more dovish stance.
These banks could gradually raise interest rates to reduce the rate differential against the dollar.
2. Market Interventions
The central banks of countries affected by the recent dollar gain can intervene directly in the foreign exchange markets by selling their dollars to stabilize their domestic currency. This is a highly effective short-term plan to counter sharp depreciation against the dollar. However, this isn’t a sustainable long-term plan because it can become very expensive and requires substantial foreign exchange reserves. The BOJ did this in 2022 and at the beginning of Q3 2024 to stimulate growth in its economy. Nonetheless, this is a good strategy to mitigate the negative impact of the growing dollar.
3. Coordinated Global Action
A historical precedent for this is the Plaza Accord of 1985, where central banks and government officials of the G5 came together to reduce the U.S. trade deficit. This is a really good approach because it employs a multilateral method to address the dangers that the strong dollar poses to developed and emerging economies.
Bottom Line?
To properly address the rising U.S. dollar, central banks of different economies must take actions to ensure they manage the situation effectively to avoid the negative impacts that a strong dollar might have on their economies. It is also important to note that a unilateral approach would most likely be ineffective and could worsen the current situation. Central banks should aim for a more multilateral approach as they progress in finding solutions to restore the balance of global trade.