The US dollar has enjoyed a longer-than-expected streak of strength despite being predicted to fall. The greenback is currently around 15% above its post-pandemic low, buoyed by the Fed’s rate hike and month-on-month good economic data despite rising borrowing costs.
However, bearish investors believe the Federal Reserve will end its rate hike policy while other policymakers continue to do so. Also that the weakening of the US economy, which has been forecast for a long time, will turn the tide against the US dollar. But what exactly does a strong dollar mean for the US economy?
What does a strong dollar mean for the US economy?
According to the Congressional Research Service, a strong dollar cannot be characterized as “good or bad for the broader economy.” Its impact is being felt more in different parts of the economy, most notably the US retail sector.
On the one hand, it can be beneficial for consumers, as it makes imports cheaper and gives them more purchasing power. It should also ease inflationary pressures, which hit a four-decade high last year, as imported commodities become cheaper.
The flip side of the coin, however, is that a strong dollar hurts US companies that do business internationally. The income they generate in other countries is worth less on the part of the state. The increased dollar has already wiped out billions in corporate profits due to lower currency conversions. Just as imports are becoming cheaper for Americans, US products are also becoming more expensive for foreign consumers relative to imported products, leading to a drop in demand.
Nominal Broad US Dollar IndexSt Louis Federal Reserve
How long will the strong dollar last?
The US economy has recovered rapidly from the pandemic-driven recession of 2020, much faster than other economies around the world. This strength has helped increase the value of the US dollar relative to other currencies. The effect was amplified when the Federal Reserve began raising interest rates, bringing the greenback back up to par with and beyond the euro for the first time in nearly twenty years.
Since then, the price has declined, but recently staged a sort of rally, surging 2.5% against a basket of currencies from its recent lows. US dollar turnaround has beaten expectations but bearish investors are waiting. The full impact of the central bank’s rate hikes has not yet been fully felt and the US economy is expected to slow.
Should the Fed start cutting interest rates while other central banks are keeping interest rates high or even raising them, it would typically result in downward pressure on the US dollar in the absence of other macroeconomic forces. This is because it would make US Treasury yields lower relative to other countries’ bonds, thus dampening demand for them as investors seek better yields in other markets.
When will the Federal Reserve cut interest rates?
Soaring prices post-pandemic due to supply and demand imbalances was one of the main reasons the Fed began raising rates at the most aggressive pace since the 1980s. After ten consecutive hikes, banks’ overnight lending rates have risen from almost zero to the range of 5.00% to 5.25% since March 2022. Futures investors are betting that policymakers will forgo a hike but a different rate at their June 13-14 meeting The rate hike could come at the July Federal Open Market Committee meeting.
When will the Federal Reserve cut interest rates? That’s everyone’s guess. However, debt traders have largely priced in the possibility of a rate cut before the end of the year. Former Fed Governor Randy Kroszner told Bloomberg that he expects rates to stay above 5% longer than many expect and could “certainly” move to 6%.
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