A stunning rise in the US dollar battered foreign currencies, hurt corporate earnings and gave investors one of the few winning trades of the year. Though the greenback has stumbled in recent weeks, recession concerns could keep it elevated in 2023.
At its peak in September, the dollar was at its highest level in almost two decades, having risen around 20% against a basket of currencies. Those year-to-date gains have been roughly halved as investors bet the Federal Reserve is closer to slowing the pace of rate hikes that have helped fuel the dollar’s gains.
While rising US yields were a key catalyst for the dollar’s rally, other factors played a major role in the dollar’s appreciation. Investors flocked to the dollar – a popular target in uncertain times – to hedge against market volatility fueled by rising global inflation, rising energy prices and Russia’s invasion of Ukraine.
The dollar’s appeal was also bolstered by the comparative strength of the US economy at a time when fears of an energy crisis plagued European assets while tight COVID-19 controls hurt China’s growth.
Even after giving up some of its gains, the dollar is still on track for its best year since 2014. Fund managers polled by BoFA Global Research in November named it the market’s busiest trade for the fifth consecutive year, and one Record number of pollsters said currency was overvalued.
Still, a Reuters poll of 66 FX strategists suggests the dollar will be trading at current levels in about a year, with many expecting tightening global central bank policy to hamper growth and boost the greenback’s safe-haven appeal again becomes.
WHY IT MATTERS
Getting the dollar right is key for investors, as its performance affects everything from corporate earnings to the prices of commodities like oil and gold.
A stronger dollar makes US exporters’ products less competitive abroad and hurts US multinationals, who have to convert their profits into dollars. The S&P 500’s foreign exposure is about 30%, according to Bank of America, with the technology and materials sectors being the most vulnerable.
Nike, IBM and Meta Platforms were among numerous companies to warn of a hit from a stronger dollar this year. According to Tom Lee, head of research at Fundstrat Global Advisors, the dollar’s rally has eroded S&P earnings by about 8% in 2022.
For the rest of the world, a stronger US currency depresses the price of oil and other dollar-denominated commodities, making them more expensive for foreign buyers while also making them more expensive for foreign companies and governments that have borrowed in dollars their fault to serve.
And while a strong greenback can depress US consumer prices, it also depresses other countries’ currencies, helping to exacerbate inflation around the world. On average, the estimated pass-through to inflation of a 10% dollar appreciation is 1%, the International Monetary Fund estimated in October.
WHAT DOES THIS MEAN FOR 2023?
There are signs that Wall Street’s sentiment towards the dollar could be changing. Data showing consumer prices fell less-than-expected in October helped the dollar fall 5% against a basket of currencies last month, its biggest monthly drop since 2010.
Futures markets saw speculative traders net short the US dollar in November for the first time in 16 months, according to calculations by Reuters using data from the US Commodity Futures Trading Commission.
Sustaining the dollar’s decline may depend on the Fed’s ability to contain inflation enough to eventually ease monetary policy. Another favorable inflation gauge in US data due next week could strengthen the case for further dollar declines.
Investors are also awaiting the conclusion of the Fed’s December 14 monetary policy meeting, when the central bank is widely expected to slow the pace of rate hikes by announcing a 50 basis point hike.
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