Making Sense of the Strength in US dollar

The US dollar still holds the tag of “Global Reserve Currency”.

so the demand for US dollar will persist even if the US economy fails to grow.

Market participants speculate the value of any currency on the basis of supply & demand factors, market sentiment and technical factors.

US dollar

Let us try to understand why the US dollar is strengthening since the start of 2018 –

Since the start of 2018, the US economy has indicated strong signs of growth, the US Federal Reserve has shown a more authoritative plan of gradual interest rate hikes, the US dollar only displayed one direction – Upside.

Obviously, trade war with China and one-sided import tariffs by the US have held the market economics of US dollar. The possibility of rise in inflation and the US creating demand for its currency by exploiting trade pacts have boosted the confidence of currency market players.

The US economy and inflation have continuously shown strong signs of growth whereas remaining nations have fallen behind significantly in this race.

Specifically, US growth and inflation is likely to keep accelerating, while the opposite is likely to happen in most major regions outside the US. Although the future looks bleak for the US economy due to steepening base effects and falling growth in the commodity prices but other nations are facing their own economic problems that severe than what US might have in future. Emerging markets foreign outflows due to their own issues such as liquidity scarcity in Argentina and Turkey, Brazil’s massive labor strike undermining government’s ability to continue reforms, economic sanctions against Russia, political uncertainty in Spain and rising current account deficit in India have also infused strength in the US dollar.

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Read: Turkey – Making Sense of the Currency and Economic Crisis 2018

A few weeks back India’s central bank governor Urjit Patel gave reasoning that tight dollar-funding conditions are the reason behind the emerging market foreign capital outflows. He also suggested that the US Federal Reserve must slow down the pace of balance sheet shrinking.

The US Federal Reserve has almost come out as a winner among the global central banks by easily trimming the excess liquidity in the market. It still continues to gradually hike the interest rates on the basis of GDP growth, employment and inflation numbers whereas other central banks are struggling to hike rates. European, Japanese and other developed nation’s central banks are not able to hike their respective interest rates because of the decelerating GDP growth and inflation.

This divergence in the central bank policies have created room for strength for the US dollar.

While the fall in other currencies due to their internal economic problem have also added strength in the US dollar, this note is only accessing the US specific reasons.

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