The risk increases that the strength of the dollar will initiate an upward spiral, known by analysts as the Doom Loop, or vicious circle, in which the factors that drive the currency feed back to push it to even higher levels, causing suffering in the currency. other currencies and hard blows to the global economy. The rest of the central banks have no choice but to increase rates to avoid weak currencies that amplify inflation.
The dollar is at a multi-decade high against most currencies, putting the euro, yen and sterling on the ropes. Jon Turek, founder of JST Advisors, points out that the current context and with s, increases the concern that the dollar enters a perverse spiral, “like never seen before.”
“What makes this version of the cycle really scary is that it’s a little hard to see how it can be stopped by automatic factors,” says the expert. Under normal conditions, inflation should go down with the interest rate hike, but “we have a European problem, which is creating pressure on the euro, which is causing the dollar to rise.”
The analyst explains that this situation complicates the manufacturing cycle. Throughout the process the cost increases, with the end result of a more expensive product. And he remembers that in 2016 or 2018 the rise of the dollar stopped, when the Fed stopped tightening its monetary policy. “But will it be the same this time?” the expert wonders.
Gita Gopinath, number two at the International Monetary Fund, and Hyun Song Shin, chief economist at the Bank for International Settlements, have shown in their work that a strong dollar causes global financial conditions to tighten and investment freezes in the economy. real. The perfect storm for countries and companies with high dollar indebtedness, such as .
This situation causes nervousness in the markets and the currencies, which makes the currency rise even more. That is one of the reasons the dollar rose when the markets crashed in March 2020 and why it has strengthened now. But also the increase in the price of raw materials increases the demand in dollars to pay the premium.
The unleashed dollar is causing central banks to move to the Fed’s pace. Turek talks about reverse currency warfare for the currency to serve as a buffer to inflation. The most significant rise has been that of the Swiss National Bank. . The move caught markets off guard. First, due to inflation, which is below 4%. And second, by the Swiss franc, which was doing its job of containing prices.
No central bank likes to openly control its currencies. . Catherine Mann, a member of the bank’s Monetary Policy Committee, noted in a speech earlier this month that “tighter US monetary policy tends to boost UK inflation due to weak sterling.” Since the end of December, interest rates in the United Kingdom have experienced five increases of 0.25%, from 0.1% to 1.25%.
“We are in this kind of reverse currency war, but I think central banks are clearly emphasizing the role of currencies, some more explicit than others, of course,” says the analyst. And he adds that “we are now in a world where central banks are dealing with above-target inflation and have very little tolerance for a weak currency because they believe it amplifies inflationary pressures.”
The Fed is no exception in wanting to curb inflation with a stronger dollar. “This vision is what makes the dollar find itself in a vicious circle that is difficult to get out of,” says Turek.
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