The US dollar loses its crown

This is an audio transcript of the Behind the Money podcast episode: ‘The US dollar loses its crown’

Michela Tindera
The FT’s Kate Duguid says that last year in currency markets, there was one story that ruled them all.

Kate Duguid
It was about the rise of the dollar.

Michela Tindera
As the Federal Reserve started raising interest rates to control inflation in the US, that sent the value of the dollar soaring.

Kate Duguid
You know the US dollar rose to its strongest level in 20 years, crushing kind of everything around it, right? We saw the dollar rise to its highest level in 20 years against the euro, its highest level in 30 years against the yen, its highest level in 40 years against the pound. So yeah, it was the story of dollar dominance.

Michela Tindera
The dollar is more than just the money used inside the United States. It’s the world’s reserve currency.

Kate Duguid
So the dollar itself is very central to the, you know, the foreign exchange market. And so that’s why a strong dollar will have such huge effects on other currencies.

Michela Tindera
These huge effects meant a few different things last year. For example, if you were an American tourist travelling the world, this was great news.

Kate Duguid
Americans travelling abroad could buy a lot more.

Michela Tindera
But for almost everyone else, not so much. Emerging market economies bore the brunt of it.

Kate Duguid
We did see countries default. We saw Sri Lanka default. We saw their currency reserves evaporate, you know, that led to food, fuel shortages. Ultimately, the ouster of the head of state. We also in December saw Ghana default on its debt. So it was a big deal, you know what I mean? Like that we hadn’t had these kind of problems in a long time.

Michela Tindera
Over the last few months, the Fed has started to take its foot off the gas. It’s slowed the pace of its interest rate hikes. And once again, the dollar story has changed. The dollar doesn’t appear to have the dominance that it did just a few months ago.

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I’m Michela Tindera from the Financial Times. Today on Behind the Money, the dollar’s lost some of the strength that gained in 2022. Now we’re looking at what that shift means for the rest of the world.

Hi, Kate. Welcome to the show.

Kate Duguid
Thanks so much for having me.

Michela Tindera
Before we get in too deep here, I need to get something straight because I think people might be listening to this and thinking, hey, you know, I have a dollar bill sitting in my wallet here. And I don’t recall that changing in value over the last year. So what do you mean by all of this when you say that the dollar has risen or decreased in value?

Kate Duguid
So like within the United States, right, we can talk about the value of a dollar changing based on what it buys. You can say that $10 buys you x amount of fuel or x amount of bread or whatever and those values will change. But when we’re talking about foreign exchange markets, were always talking about currency pairs, OK? So we’re talking about an exchange rate. You’re saying that the dollar is at a 20-year-low, and that is against the euro, right? It was at a 30-year low against the yen, a 40 year low against the pound, right? And so, and so that’s what we’re comparing it to. We’re comparing it to other currencies.

Michela Tindera
Aha. OK. That makes sense. So in September of last year, the dollar hit these peaks against other currencies. What was causing that?

Kate Duguid
The Fed was on this aggressive interest rate hiking campaign. They were really aggressively raising interest rates to control inflation, and the dollar rises with interest rates. And the reason for that is because when interest rates go higher, the yields on US government debt also goes up. So what that tends to do is it tends to attract foreign investors who sell, you know, whatever assets in their own currency and buy up US-denominated debt, right? And so that flow of cash into the United States strengthens the dollar. And so that is the primary reason that the dollar was so strong last year.

Michela Tindera
So the Fed raises interest rates and that pushes the value of the dollar up against other currencies. So was that the only reason that this was happening then?

Kate Duguid
There was kind of like just this confluence of things that were happening, right? The other thing was the war in Ukraine. And there are certain economies — so the UK, Europe, Japan — that are highly dependent on importing commodities. And so what happened to those countries is that what’s called the terms of trade, the cost of their imports versus the cost of their exports, was heavily skewed. And so, you know, it cost them a ton of money to import commodities, right? We saw commodity prices, like in particular oil, go up dramatically last year because of the war in Ukraine. And so that was another thing that was weakening their currencies. And again, the story is really like money flowing in to a country or money flowing out, right? If there’s money flowing out of a country, their currency is weakening. If there’s money flowing in, their currency is, you know, typically strengthening.

Michela Tindera
Yeah. OK. So the dollar was at these highs against the euro, pound and yen last year. What did that mean for those countries and for the wider economy?

Kate Duguid
So what it meant was those countries’ currencies were being devalued, and in a lot of those places it also meant that inflation was being driven higher just because of the stronger dollar. There was also a huge effect on emerging markets, right? So, you know, there was the currency effect that we see sort of all over the world outside of the United States, which was affecting them, but the other thing is that emerging market countries typically cannot borrow in their own currencies because their currencies may be more volatile. And so typically they borrow in dollars, their debt is dollar denominated. And so what that meant was that their interest payments were going higher and higher with the value of the dollar. So there are two things that kind of were hurting emerging markets, right? It was both the currency effect and it was the effect of the dollar denominated debt.

Michela Tindera
Right and so that’s where we saw Sri Lanka default on its debt and Ghana, too. But now it’s February 2023, and the story’s changed. The dollar is at its lowest point since April 2022. So what happened?

Kate Duguid
So this story has changed, and it’s changed for a number of different reasons, right? First is about the Fed, right? What has happened is that the Federal Reserve has slowed its pace of interest rate hikes. This has happened as inflation has cooled and as the economy has slowed right? The Fed is kind of approaching the end of its hiking cycle. So as it’s doing that, the dollar has also come off of these peaks.

Michela Tindera
OK. So that’s the first reason the dollar’s fallen. But what else?

Kate Duguid
The second reason is, is to do with commodity prices, right? Commodity prices are falling, which has improved the terms of trade for countries that are heavily dependent on imports. We’ve also seen some other things, right. One is, is that the chance of recession in Europe has fallen. So when we’re talking about currencies, we’re always talking about money flowing in to a country versus money leaving a country. A stronger euro means more money going in to Europe, meaning the dollar weakens in response. We also have this last story, which is about the reopening of China. That has kind of had mixed effects. But in the same way that we were talking about the European economy strengthening, an open China means more money flowing in to the Chinese economy.

Michela Tindera
OK. So the dollar becoming so strong had all these different ripple effects outward. But what does it mean now that the dollar’s fallen?

Kate Duguid
The story of dollar dominance was a story about the Fed leading the charge to raise interest rates. You know, these other central banks were also raising rates, but they were just doing it at a slower pace than the Fed. And so though they were raising rates, the benefits were not really accruing to them because the US was so far ahead in this process. Yeah, we’re doing something a little bit different now. The Fed stepped back, right? And so the Fed is no longer in the driver’s seat. The dollar is no longer in the driver’s seat, right? That this is a story about a number of different things, right? It’s not just about the Fed. It’s about other central banks, but it’s also about these other topics that we’ve started to talk about. Commodity prices coming down, which has meant that for countries that are heavily dependent on commodity imports — so Japan, the UK, Europe — that their costs have gone down, and, you know, the cost of imports has gone down, which means that those currencies have strengthened as well. So, you know, it’s two things. It’s one, it’s that the Fed has kind of taken a step back. But it’s also that the Fed is no longer the only story.

Michela Tindera
So where would you say this has had the largest impact?

Kate Duguid
You know, I think that one of the places is, is emerging markets, right? In recent weeks, investors have been piling into emerging market equities and debt. Our colleague in London, Jonathan Wheatley, had a piece about this about how, like, I think it was it was the last week of January, emerging market debt and equities were attracting $1.1bn a day in inflows. And so, you know, so that’s really kind of eased the pressure on emerging markets. So I think that that’s probably the biggest part of the story. You know, we were talking about the fact that in emerging markets you have this twofold effect of a strong dollar rate. One is, is on the currency directly, but the other is about dollar-denominated bonds, right? And so while payments in dollars are still high, they’re not rising. In fact, they’re falling a little bit from their peaks last year. And so there’s relief there as well.

Michela Tindera
If it’s good for emerging markets, does that mean it’s a problem for the US then? Does it work like two ends of a see-saw?

Kate Duguid
Yeah, you know, it may be slightly bad for the US, but it’s certainly great for the rest of the world. And I think that that’s sort of the biggest thing, right? That in the US, the falling value of the dollar is not hugely concerning. It means less inflation abroad. It means, you know, it means that the values of of, of currencies outside the United States will be higher. So really, it’s, it’s honestly like a good story. As the dollar ascends, it kind of crushes everything else. And so, and so the rest of the world can maybe breathe a little bit of a sigh of relief as the dollar is weakening.

Michela Tindera
And what about US businesses? How are they navigating this change?

Kate Duguid
Last year, we saw a bunch of US companies blame weaker earnings on the strong dollar. So companies that have big exposures internationally, so a tech company, for example, you know, somebody like Microsoft, somebody like IBM, somebody like Amazon may struggle because if they’re selling products overseas and they’re selling their products in dollars, their products will become more expensive relative to local rivals, meaning that their products are less competitive. They’re less desirable. They sell less overseas. So companies with big international presences really were hit hard last year. We can probably see that, that pressure on them being relieved a little bit this year.

Michela Tindera
Hmm. OK. So where do you see the story going the rest of the year?

Kate Duguid
Oh, it’s such a good question (laughs). You know, the market at the moment, is expecting the Fed to raise interest rates one more time and then cut interest rates as soon as the fourth quarter. The market is really betting that the Fed is going to, not just have to slow its roll, but also cut. If that happens, we will see the dollar plumbed new lows, not historic lows, but for this year. It’s kind of unclear whether or not that’ll happen. There’s like this real divergence between what the market thinks the Fed is going to do or what the Fed has said it will do. It seems kind of unlikely that the dollar will reach the peaks that it did last year, but that, that has yet to be determined. We had an employment report from the US last week which showed that the US added about half a million jobs in January, which was triple what people had expected. We also saw that the unemployment rate was at 3.4 per cent, which was the lowest it’s been in 53 years. Data like that suggests that the US economy is continuing to run hot, and the Fed may continue to need to take aggressive action in order to cool it down. So something like that may ultimately push the dollar higher for a little while. But it is, it is unlikely that we will reach the same peaks that we did last year. You know, like the Fed has said, as has the, the European Central Bank and the Bank of England, has said that they will become much more data dependent. You know, it’s funny because investors initially took that message of data dependence to be a dovish one, right? To indicate that the Fed and the ECB and the Bank of England would not raise rates much further. But then you get data like this. And so the jobs number from last week really kind of throws a wrench into this story. And it’ll be interesting to see where things go from here.

Michela Tindera
Yeah. Yeah. Well, I’m sure you’ll be watching all of the data . . . 

Kate Duguid
(Awkwardly laughs)

Michela Tindera
 . . . come in and keeping us updated.

Kate Duguid
I will do. I will do.

Michela Tindera
Thanks so much, Kate.

Kate Duguid
Thank you so much for having me.

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Behind the Money is hosted by me, Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Special thanks to Jennifer Hughes. Cheryl Brumley is the global head of audio. Thanks for listening. See you next week.