Source: Finance Federation Author: Huang Junzhi

The US dollar is expected to achieve its biggest increase in more than a year because the market expects US interest rates to remain high for a longer period of time, and investors are pouring into this safe-haven currency as tension in the Middle East escalates.

The Bloomberg Dollar Spot Index (Bloomberg Dollar Spot Index) climbed for the fifth day in a row on Tuesday, with an increase of about 2%, the biggest increase since February 2023. Chris Turner, head of foreign exchange strategy at Dutch International Group, said: “It is difficult to counter the dollar's bullish trend right now.” He anticipates that the index may rise another 1.2% to 1,280 points, which will be the highest level since October last year.

The US March CPI data released last week once again exceeded expectations, causing investors to reduce their bets on the number and extent of the Fed's interest rate cuts this year. Powell's latest remarks have further worsened this expectation. He said on Tuesday that the US economy is showing strong performance in most aspects, except that inflation has not yet returned to the central bank's target. He also pointed out that the Federal Reserve is unlikely to cut interest rates anytime soon.

Powell mentioned that the Federal Reserve's preferred inflation indicator, the personal consumption expenditure (PCE) price index for February had an annual rate of 2.8%. “It clearly didn't give us more confidence; on the contrary, it showed that it might take longer than expected to gain that confidence.”

On the same day, Federal Reserve Vice Chairman Philip Jefferson (Philip Jefferson) also said that if US inflation does not slow as expected, the most important central bank in the global financial system will be prepared to keep its tight monetary policy unchanged.

The market was forced to be helpless and once again adjusted its expectations for interest rate cuts. The CME Federal Reserve's observation tool shows that as of press release, the market currently expects the Fed to cut interest rates only once in September this year.

On the other hand, a new round of risk aversion is also spreading in the market, intensifying the rise of the US dollar. Senior Israeli military officials have reiterated that their country had no choice but to respond to Iran's weekend drone and missile attacks, increasing the possibility of a wider war.

“Increased geopolitical uncertainty is the icing on the cake,” said Roberto Cobo Garcia, head of G10 foreign exchange strategy at Banco Bilbao Vizcaya Argentaria SA in Madrid. He was referring to the appeal of the US dollar as a safe-haven currency.

Furthermore, policy differences have begun to arise between the Federal Reserve and other major central banks, such as the European Central Bank. The ECB has hinted that it will start cutting interest rates in June, which has boosted the dollar against all major currencies while increasing market volatility.

The strengthening of the US dollar raises concerns

As the dollar continues to strengthen, some investors are beginning to worry that this will drag down the financial system outside of the US. Quentin Fitzsimmons, global fixed income portfolio manager at T. Rowe Price Group Inc. (T. Rowe Price Group Inc.), believes that this may lead to a tightening of the global financial environment.

Furthermore, as the US dollar continues to strengthen, emerging market currencies have fallen sharply since this year: the Indian rupee has fallen to a record level, and the Malaysian ringgit is approaching its lowest level since the 1998 Asian financial crisis. Of the 23 major developing country currencies tracked by Bloomberg, 22 have experienced a decline in exchange rates against the US dollar this year.

Analysts pointed out that high US interest rates mean that investors can get considerable returns from holding dollars without having to bear the exchange rate risks associated with investing capital in emerging markets.

Custody data held by State Street (State Street) shows that in the five days ending April 11, the volume of institutional capital inflows into the US dollar reached the highest level since November 2022. Asset management companies have been selling the euro, and they have already begun to reduce their holdings of the euro due to growing confidence that the ECB will cut interest rates. There has also been an outflow of funds from the Canadian dollar.

Nathan Thooft, global chief investment officer and senior portfolio manager of the multi-asset solutions team at investment management company Manulife Investment Management, said: “One of our biggest concerns is that the dollar will continue to strengthen and the situation will get worse. The Federal Reserve will eventually need to join this party, otherwise the dollar's dynamics will cause greater damage to the US and the wider global economy.”

edit/lambor