economic-analysis:-reasons-to-worry-about-the-strong-dollar

The authors are economists of Shinhan Investment Corp. They can be reached at keonhyeong.ha@shinhan.com. — Ed.

USD could continue further upward even after the recent hike in value

The USD value has sharply increased, with the US Dollar Index (DXY) jumping near 110pt in September, up more than 20% from lows of 90pt reached on economic recovery from aggressive liquidity injection at the start of the pandemic. The USD rally has been driven by: 1) differentiated impact of the energy crisis on certain countries; 2) relative weakness of the manufacturing sector; and 3) monetary policy divergence among advanced economies. Although monetary policies are now starting to converge, we see no signs of the USD losing its upward momentum anytime soon.

Instead, the global energy crisis and weak manufacturing activities may drive the USD even higher going forward. Net energy importers in Asia and Europe will find themselves at a disadvantage against the net energy exporting US as long as the energy crisis triggered by Russia’s invasion of Ukraine persists. With the focus of pandemic-driven pent-up demand shifting from goods to services, the manufacturing sector is remaining relatively weak vs. the service sector and demand for cyclical goods are likely to take a blow as the world economy slides into recession.

Reasons to worry about the strong dollar

Strong USD periods since the 1980s include the early-1980s Latin America debt crisis, mid-1990s Asian financial crisis, 2008 financial crisis, and the 2015 CNY shock period. Unlike in the past, financial uncertainties have remained mostly localized amid the recent hike in USD value, thanks to relatively sound conditions in emerging economies, decent global demand, and limited international capital flows. Financial crises, however, were typically triggered when economic fundamentals took a hit. With trade expected to come to a standstill on slowing demand from 4Q22 and rate hikes in the US nearing an end, massive capital outflows are now a concern for countries in Asia and Europe that saw inflows during the pandemic.

 

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