The Dollar's Challenging Month: A Silver Lining in Sight
The US dollar is set to record its worst monthly performance in a year, with a 37% loss against major currencies This brings winners and losers into focus
The US dollar is on track to lose 3.7% this month against a basket of six major currencies, marking its worst monthly performance in a year. While this is positive for countries dependent on importing commodities traded in dollars and for nations repaying dollar-denominated debt, it could mean higher costs for American businesses and consumers purchasing imported goods.
Between mid-July and early October, the US Dollar Index saw a significant surge of over 7%, driven by a series of positive economic data from the United States. This has fueled expectations that the Federal Reserve will maintain high interest rates. When interest rates are high, it typically leads to an increase in the value of the currency as it attracts more foreign capital into the country, with investors seeking larger returns. This greater demand for the currency contributes to its appreciation.
Single-family homes are seen in this aerial photograph taken over a Lennar Corp. development in San Diego, California, U.S., on Tuesday, Sept. 1, 2020.
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In recent weeks, indicators of a slowdown in the US economy have led investors to believe that the Fed will stop raising borrowing rates and will instead begin to lower them. "I anticipate that the US dollar will continue to weaken for two more quarters, especially if it becomes evident that the Fed plans to reduce interest rates," said Ulrich Leuchtmann, head of foreign exchange research at Commerzbank, in an interview with CNN.
Cameron Willard, a member of the UK capital markets team at Swedish bank Handelsbanken, anticipates a continued gradual decline in the value of the dollar in the first half of the upcoming year. However, he believes that the greenback will likely change its course later in the year due to geopolitical risks, such as uncertainty surrounding the outcomes of various countries' elections. During times of instability, investors typically view the dollar as a safe haven where their funds can maintain their value.
Who wins?
Willard expressed doubt about the possibility of a longer-term dollar depreciation in an interview with CNN. He emphasized the need for a credible alternative for such a depreciation to occur, citing the dollar's status as the world's reserve currency and the safest currency globally, which he does not foresee changing.
Countries that rely on importing commodities will benefit from a weaker dollar, as it means they will spend less on necessities such as wheat and crude oil. This in turn has the potential to lower overall inflation rates in these economies. For instance, Japan, Korea, India, and several eurozone countries are heavily dependent on importing commodities, according to Mark McCormick, who serves as the global head of foreign exchange and emerging markets strategy at TD Securities.
American exporters can also benefit from a drop in the price of their products in other currencies, making them more competitive on the international market. Conversely, a weaker dollar can drive up the cost of imports into the United States, giving American companies selling domestic products an advantage against foreign competitors.
This is also positive news for developing economies. Many growing economies have debts in US dollars, and a weaker dollar can reduce the cost of repaying those debts. Additionally, the decrease in the dollar's value indicates more favorable investment prospects beyond the United States, according to McCormick in an interview with CNN.
"A weaker dollar is a rising tide that lifts all boats," he said.
And who loses?
A weaker dollar spells trouble for American consumers, who will likely see higher prices for imported items like French wine or Chinese-made toys, as well as increased expenses for vacations abroad.
"Essentially, a declining dollar means that the US is at a bit of a disadvantage because they are shelling out more for imported goods and receiving less for their exports," Leuchtmann explained.
He added that, all other things being equal, this contributes to inflation, but the rate of price increases is also impacted by other factors. "I believe that inflation will continue to decrease in the US, but the pace of this decline will be slower if the dollar remains strong," he stated.
Willard from Handelsbanken believes that the cooling US labor and housing markets will help keep headline inflation in check, even with rising import prices. "I don't think the Fed will be too concerned at this point," he stated.
