Strong US dollar hurting emerging economies

 “The markets have consistently tried to price in rosy scenarios which were associated with a weaker dollar and they continue to be surprised that the reality isn’t quite as rosy,” said Maurice Obstfeld, former chief economist at the International Monetary Fund.

The strong dollar “is going to be negative for emerging markets. It’s going to be negative for global trade,” he said.

So far at least, the damage has been less widespread than last year, when the dollar surge led to a historic selloff in emerging-market assets and helped tip countries like Sri Lanka and Ghana into full-blown economic crises.

In recent months, currencies in Latin America and Eastern Europe have been hit hard. Central banks in Brazil, Poland and Hungary have started cutting policy rates after winning praise for their quick action to tighten monetary policy in 2021, well ahead of the Fed and other developed-market central banks. They are now under pressure to pause or slow rate-cutting plans to prevent further pressure on their currencies.

A stronger dollar is felt broadly in emerging markets. A paper co-written by Obstfeld last year showed how the shock of a sharp rise in the dollar leads to yearslong economic underperformance in less developed economies. Consumption, output, investment and government spending all come under pressure alongside the local currency.

“It’s a double whammy,” he said. “You’re being driven away from your growth target and you’re being driven away from your inflation target at the same time.”

Some global central banks are tapping into stockpiles of foreign currency to help shore up their currencies. Others are publicly threatening to do so, a tactic known as jawboning.

Japanese Finance Minister Shunichi Suzuki on Friday pledged to take action against sharp falls in the yen, which is close to 150 a dollar. That is around the level that last year spurred the

“We will take appropriate action against excessive moves without ruling out any options,” Suzuki said. “We have a strong sense of urgency.”

Both Switzerland and South Korea have sold foreign-currency reserves to bolster their currencies, the franc and the won. Analysts believe China is helping prop up the yuan, which fell to a 16-year low in onshore trading in September, by having state banks sell dollars.

Investors had largely expected the greenback to weaken this year as the Fed wound down its most aggressive campaign of interest-rate increases since the 1980s. Indeed, in the first half of the year, beaten-down currencies like the British pound and euro rebounded from 2022’s brutal declines.

But those rallies have petered out. The euro, which topped $1.10 over the summer, has fallen back toward $1.05 as the eurozone economy stagnates and worries over debt sustainability in fragile southern economies like Italy re-emerge.

Many investors still hope the dollar’s decadelong winning streak, which has left it at least 10% overvalued by many estimates, is coming to an end.

One factor could be fading American growth. U.S. consumers have been running down their $2 trillion-plus in pandemic-era savings and the resumption of student-loan payments is expected to further dent consumption. The unemployment rate, while still near historic lows, has been edging up.

U.S. growth is likely to fall in line with the rest of the world in 2024, said Luca Paolini, chief strategist at Pictet Asset Management. The dollar’s recent rally is “the last hurrah before a significant decline next year,” he said.

Anonymous