Reasons why the US dollar is climbing Details
Posted Monday, March 28, 2022 12:03 (AM) by- Kevin Smith
Reasons why the US dollar is climbing

Reasons why the US dollar is climbing

So far this year, the US dollar, sometimes known as the greenback or the "buck," has maintained its position as "king of the foreign exchange world." To far in 2022, the benchmark dollar index (DXY), which measures how the USD has performed relative to a basket of key rivals such as the euro, the pound, and the yen, has risen by more than 3.3 percent, and it is now trading at its best levels since May 2020. In addition, the dollar has gained ground against most of its G10 counterparts as well as against all Asian currencies so far this year.

So why has the dollar been so strong?

Here are 3 reasons

The Fed is raising interest rates

The value of a country's currency tends to rise in tandem with the value of its interest rates. The Federal Reserve hiked interest rates by 25 basis points last week, marking the first time the bank has done so since December 2018. More crucially, the Fed signaled that it may raise interest rates another six times for the remainder of this year, with the potential of a 50-basis point increase in May cited as one option. If you did that, it would be equivalent to shooting two bullets with one shot. As markets brace themselves for rising interest rates, the value of the US dollar has risen in tandem.

Economic resilience

In spite of rising interest rates (which typically translate into slower economic growth), the US economy is expected to fare better than its major peers, namely the European Union (which is embroiled in an all-out war to its east) and the United Kingdom (which is embroiled in a civil war to its west). For example, the United States is less dependant on Russia for oil and natural gas than the European Union and the United Kingdom. Following its policy meeting earlier this month, the Bank of England has already begun to cast doubt on the extent to which interest rates may be raised in the future, sounding more 'dovish' in its tone. The European Central Bank is still pushing forward with its plans to increase interest rates, but markets are questioning how much further the ECB can raise rates given the possible consequences from the greatest security crisis the region has had since the Second World War. As previously stated, since the euro and British pound account for about 70% of the DXY's total value, the relative strength of the US economy as compared to the EU and UK should keep the DXY well supported.

Safe haven demand

When markets are experiencing increased volatility, the US dollar is seen as a safe haven asset that may safeguard investors' money. In these times of enormous uncertainty, the US dollar extends a warm welcome to investors from all around the world. After all, the dollar is the world's reserve currency, it is the most extensively used currency in cross-border transactions, and it is the currency of the world's biggest economy, the United States of America. However, this does not imply that the value of the US dollar is rising against every single currency in the world.

In fact, within the G10 space, the US dollar has weakened against these four currencies thus far in 2022:

  • Australian dollar (AUD): 3.2%
  • Norwegian krone (NOK): 2.5%
  • New Zealand dollar (NZD): 1.9%
  • Canadian dollar (CAD): 0.7%

(percent figures reflect currency's year-to-date performance against the US dollar)

And here are two main reasons why the above-listed currencies have strengthened against the greenback:

  • Their central banks have also raised interest rates, except for the Reserve Bank of Australia, for now. 
  • More influential is the fact that markets believe that these central banks are ready to raise rates even higher in order to bring down roaring inflation. 

These countries' economy are heavily dependent on commodities. Companies in these nations, as well as their governments, expect to gain financially as a result of the recent increase in commodity prices. Higher money moving into its economy equals more demand for its currency, which translates into currency strength for the country.

The same reasoning can be used to currencies such as the Brazilian Real, which has been the best-performing emerging-market currency versus the US dollar so far this year, and other emerging-market currencies. Overall, the US dollar is anticipated to sustain its strength for the remainder of 2022, and maybe beyond that year as well.

Although, as previously said, not all currencies are created equal, there are still a handful of currencies that have the potential to surpass the 'king dollar' this year, as mentioned above.

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