- The Federal Reserve’s aggressive rate rises have caused central banks around the world to scramble to keep up.
- A strong dollar places others in a losing position: either fight inflation or slow growth, or let prices continue to rise.
- Countries tend to choose the former and the US’s current slump could be worsened by a wide-ranging slowdown.
As the US dollar becomes stronger, it comes at the cost of other currencies around the globe.
As the Federal Reserve has implemented historically high interest rate hikes to combat inflation, the dollar has become stronger in the second half of 2022. The rally has placed central banks around the world in a race to see who can lift interest rates — and, by extension, the value of their money — faster to keep up.
As it stands now, the Fed still commands a healthy lead — a designation that raises the stakes for any further policy moves it makes.
While the ongoing “Inverse Currency WarAlthough “” may sound like good news to the US, slowdowns in the global economy can have a negative impact on the US.
The Fed is now faced with a tough choice. Stopping the hike cycle would ease pressure on other nations to raise rates but could cause the US to continue to experience high inflation.
While aggressive tightening could help to curb the rise in prices in the States, it would also slow down economic growth. The risk of a US recession would rise with widespread layoffs as well as weak wage growth and plummeting investment balances.
The US’s policy is making the rest of the world scramble to keep up
Fed Chair Jerome Powell reiterated on September 21 that the central banking would not stop raising rates beyond “”It’s done!.” Major economies such as the UK, Japan and China are at risk of a prolonged economic downturn due to large-scale rate increases. These countries must either increase their rates and risk recession, as their currencies are already weakening in relation to the dollar, or allow the dollar’s strength to further diminish their currencies’ value.
More than 80 central banks across the globe are now following the Fed’s example. They are continuing the tightening plans that kicked off earlier this year and moving aggressively to cool their own unique kinds of inflation.
However, there is very little coordination among policymakers. Instead of officials working together to curb global inflation, central banks rush to prop up their currencies as fast and as efficiently as possible.
The UK’s Conservative government created a tax-cutting program to stimulate the economy amid concerns of a slowdown. The proposal was so incompatible with the economic consensus, however, that it was thrown out. It was rebuked by the IMF — and disrupted the Bank of England’s rate-hiking efforts.
The Pound Record low plunge against the dollar and prices on gilts — the UK government’s bonds — also nosedived as investors grew increasingly fearful of a ballooning deficit.
The Bank of England announced that it would Start buying government bonds, and defer its attempts to reduce its balance sheetTo stabilize the debt markets. However, the bank’s repurchasing programme will provide more cash for the UK economy in a time when inflation has already reached 9.9%.
The alternative is not more appealing. A failure to support the pound and to ease the selloff could lead to a steeper fall for the currency. It would drastically increase import pricesIn a country where nearly half its food is already imported and the majority of its energy comes from other countries.
The UK will be closer to severe recession as prices rise across the board. Inflation tends to reduce demand, as households cut back on spending to maintain their finances. Lower revenues can lead to lower spending, which leads to layoffs and a vicious cycle that causes economic decline.
Other central banks are also taking stronger action to support their currencies against the US dollar and prevent rising import costs. The Bank of Japan is seeing the yen trade at 24-year lows. This month, the government intervened in order to boost the currency’s value.Tokyo intervened directly in the currency market for the first time since 1998, by buying the native currency and dumping dollars.
Japan — which has historically struggled with deflation, rather than inflation — isn’t seeing prices soar at the same rate as countries like the US and the UK.
There are signs that the pressures are building. According to the International Import Association, import volumes increased by nearly a third in the last year. Deloitte. These imports become more expensive due to the depreciation of the yen, which in turn makes inflation higher.
The Bank of Japan stated that it will continue to use monetary policies If the price stability of the currency is threatened by a freefall, to support the yen, but the interest rate hikes needed to do so could cause growth to stagnate.
The People’s Bank of China also helped to boost the economy renminbiIt is currently in its worst year since 1994. It has Major state-run banking institutions were instructed to sell their dollars and buy yuan offshore..
However, China’s banks will be forced to tighten balance sheets in a time of slowing economic growth. Beijing’s ‘zero-Covid’ approach to pandemic lockdowns has led to a sharp decline in business activity, and the government recently slashed its annual GDP projection to 2.8% — just over half its 5.5% target.
China was not forced to keep its population locked down by the Fed, and Jerome Powell wasn’t responsible either for the tax-cutting policies of the UK Conservative Party. As other central banks look to defend their currencies from the rising dollar, however, China’s aggressive rate hikes have created a global economic chaos.
Ayhan Kose (acting vice president for equitable growth and finance at the World Bank) stated in a recent report that “recent tightening monetary and fiscal policy will likely prove useful in reducing inflation.” Because they are very synchronous between countries, they could be mutually enhancing in tightening financial conditions as well as steepening the global slowdown.
While the US leads the way for now, its dominance can quickly backfire
The Fed isn’t giving up in this game central-bank chicken. The September 21 projections suggest that policymakers will raise interest rate by another 1.25 percent before the end, and keep increasing them through 2023.
Powell suggested that the Fed would err on one side of tightening. This means that he prefers to risk a downturn than allow inflation to run wild. In his September 21 press conference, Powell repeatedly stated that subpar growth and higher unemployment are likely to be necessary in order to balance the economy and reduce inflation. In his Annual speech in Jackson Hole WyomingPowell emphasized the importance of fighting inflation with force to avoid worse consequences later.
“History has shown that inflation increases with time, as wages and prices are set higher,” he stated.
But Powell seems to be taking a “soft-ish landing” scenario — when rate hikes only lead to a moderate economic slowdown — for granted. Powell’s hawkish statements may fuel global inflation if other central banks are forced into aggressive rate hikes to keep up with the dollar’s appreciation. Recessions in growthThis will come back to bite the US.
The US relies on imports to maintain a steady supply of goods like food, crude oil, and car parts — and the price of those goods is directly connected to the performance of other global economies.
China is a good example. Manufacturing and industrial activity will likely fall if Beijing’s attempts at supporting the yuan against USD lead to a recession in China. That would mean China produces less of the goods it tends to export to the US — such as aluminum, glass, and wood.
As the supply of these goods decreases, import prices will likely rise. American importers would be left with a choice between passing those higher costs onto consumers or seeing their profit levels take a major hit — with either route contributing to a harsher recession.
What began as an attempt to control US inflation will suddenly turn into a global crisis.