Wrestling the Dollar

There’s no two ways about it: the USD has had one of the most challenging and unexpected years on record, from sparking a massive recovery to riding a wave that seems to be passing on said challenges to virtually every other major currency around the world, thus sparking volatility in the forex market. Analysts have been voicing concerns that high US interest rates could damage the economy, but the US Federal Reserve’s passion for taming inflation had not cooled by October. The US currency, as a result, had been advancing unchecked for four months. The ripple effects of the policy reached many parts of the globe, sharply impacting developing nations who must pay back debt valued in dollars as well as pay for dollar-priced imports.

US Treasury Secretary Janet Yellen, however, insisted in October that a “market determined value of the dollar is in America’s interest” and that these ripple effects were the “logical outcome” of necessary central bank policy. According to Jessica Amir of Saxo Capital Markets, Yellen’s statement itself meant that “The green light is certainly there from authorities for a stronger dollar, and that’s a big tick for investors”.

Let’s take a closer look at how the USD has performed in recent months, and how its interactions with other major currencies have rocked the forex trading market.

EUR/USD

Running up to the end of October, the euro achieved more in its rivalry against the dollar than it had in five months. The sense of confidence that Europe was well-stocked with gas for winter propped up the common currency for several weeks. This was after a September trough in which the euro dropped to its lowest against the dollar since 2002.

But, as October closed off, the euro got cold feet as traders decided the Fed would continue to act hawkishly into the near future. “We’re expecting the euro to peter out and gradually start to go back down again below parity”, predicted Lee Hardman of MUFG. One of the main reasons forex traders sell the euro is because they expect the interest rate differential between the US and the euro zone to favour the dollar. This seemed to be the case, “thanks to a Fed laser-focused on inflation”, in the words of Luc Luyet of Pictet Wealth Management. For reference, the EUR/USD was holding at 0.9955 on October 28th.

GBP/USD

When Liz Truss stepped into office as the UK’s new Prime Minister in early September, the pound, which was already reeling due to the relentless gains of the USD, dropped to $1,1406, its weakest since 1985, because of her plans to run the budget deficit higher. “Truss’s fiscal plans may help households but probably not the pound”, remarked Roberto Cobo Garcia of BBVA.

Two months later, when Truss no longer lived in Downing Street, the Bank of England said they believed the UK would be in recession until 2024, and this nudged sterling into even lower territory. Policymakers, battling to control inflation, had dealt the economy the biggest interest rate hike in over three decades at the start of November, bringing the cost of borrowing up to 3%. Many analysts, including Deutsche Bank, thought the GBP/USD would descend below 1.10 by year’s end. 2022 was, for the pound, the worst year since 2008 (which, we probably don’t need to remind you, was the year of the great financial crash). Looking for signs of a brighter future, Cobo Garcia said “Global risk appetite may need to improve somehow to stop the pound carnage”.

USD/JPY

The strange phenomenon that occurred near the end of October was a sudden and considerable appreciation of the Japanese yen against the USD without an apparent cause. The USD/JPY ticked over within a couple of days all the way from 152 to 146. Although Janet Yellen could not corroborate this, experts deduced that Japanese policymakers had spent about $37 billion to prop up their currency. It’s certain they did intervene in the forex market back in September, when the USD/JPY was at about 145. The weeks in between, however, had succeeded in pushing the yen back down by 4%. The yen’s tumble against the dollar has been driven by the contrast between the Fed’s aggressive monetary tightening and the Bank of Japan’s immovable patience.

Looking Ahead

Near the end of October, the UN’s International Labour Organization (ILO) warned that “Uncoordinated monetary and fiscal tightening will further depress global economic growth”. Indeed, a constant question in the minds of central bankers on both sides of the Atlantic has been whether to loosen monetary policy sooner or later. The more that symptoms of ailing economies emerge in coming weeks or months, the more central banks will feel the pressure to do a U-turn on tightening.

According to the ILO, the Ukraine crisis has raised food and energy prices, while also exacerbating price volatility around the world, to the extent that it’s likely there’ll be a recession in 2023. How this will affect the forex trading market is still up in the air, but it’s vital forex traders keep an eye on the latest international policy announcements in order to make more informed trading decisions.