The Federal Reserve is utterly committed to halting price rises in the US. But when their central banks are compelled to raise interest rates quicker and higher and a runaway dollar drags down the value of their currencies, countries thousands of miles distant are bleeding from its hardball campaign to strangle inflation.
The Fed is currently acting as aggressively as it has since the early 1980s. They’re prepared to put up with increased unemployment and a downturn, according to Chris Turner, global head of markets at ING. “That’s not helpful for global development.”
The Federal Reserve’s decision to increase rates by three-quarters of a percentage point at three successive meetings, while also indicating that more significant increases are imminent, has encouraged its peers worldwide to tighten their policies as well. Investors may withdraw funds from their financial markets, seriously disrupting things, if they lag behind the Fed by a significant amount.
Following the Fed in raising rates during the past week were central banks of Switzerland, the United Kingdom, Norway, Indonesia, South Africa, Taiwan, Nigeria, and the Philippines.
The Fed’s attitude has also caused the dollar’s value against a basket of major currencies to reach two-decade highs. The value of the yuan, yen, rupee, euro, and pound all decline, making it more expensive to import basic necessities like food and fuel. While this is good news for Americans who wish to shop overseas, it is very bad news for other nations. The Fed is essentially exporting inflation in this scenario, which puts additional pressure on regional central banks.
“The dollar doesn’t grow all by itself. According to James Ashley, head of global market strategy at Goldman Sachs Asset Management, “it has to strengthen versus something.
In recent days, it has become more obvious what the painful effects of the dollar’s sharp rise are. For the first time in 24 years, Japan intervened last Thursday to support the yen, which has fallen 26% versus the dollar so far this year. (Despite an increase in inflation, the Bank of Japan has continued to be an outlier among major central banks by refusing to raise rates.)
China is keeping an eye on the currency markets after the yuan traded domestically fell to its lowest level against the dollar since the global financial crisis, while Christine Lagarde, president of the European Central Bank, issued a warning Monday that the sharp decline in the value of the euro has “added to the build-up of inflationary pressures.”
The United Kingdom serves as an example of how quickly things may get out of hand because investors around the world shunned the new government’s economic growth strategy. On Monday, the British pound hit a record low versus the dollar after concerns were raised about the unconventional experiment of enacting significant tax cuts while increasing borrowing.
The subsequent upheaval compelled the Bank of England to undertake an emergency bond-buying programme in an effort to calm the markets, and the IMF warned the UK government to reevaluate its plans as a result.
According to Turner, the current state of the world financial system is “like a pressure cooker.” You must have reliable, solid policies, and any violations of such policies will result in sanctions.
Developing markets are in danger
The chance of a worldwide recession in 2023 has increased, according to a recent warning from the World Bank, as central banks throughout the world raise interest rates at the same time in reaction to inflation. A succession of financial crises among emerging economies, many of which are still recovering from the pandemic, might result from the pattern, according to the report, and “would do them lasting harm.”
The nations that have issued debt with a dollar value may be the ones to experience the most negative effects. As local currencies lose value, it becomes more expensive to repay such debts, requiring governments to reduce investment in other areas at the same time that inflation is destroying living standards.
Concerns about declining currency reserves are also warranted. The biggest economic crisis in Sri Lanka’s history and the removal of the president earlier this year were both caused by a lack of dollars in the country.
The magnitude of interest rate increases in several of these nations exposes the concerns. Brazil, for instance, maintained interest rates this month, but only following 12 straight increases that raised its benchmark rate to 13.75%.
Rates were increased by Nigeria’s central bank on Tuesday to 15.5%, significantly more than experts had predicted. The central bank stated in a statement that “the US Federal Reserve Bank’s continued tightening of monetary policy is also placing upward pressure on local currencies throughout the world, with pass-through to domestic pricing.”
Can one halt the pain?
The Plaza Accord, which was proclaimed by officials in the United States, Japan, Germany, France, and the United Kingdom in the early 1980s, was the last time the dollar saw a similar decline.
It has been suggested that it might be time for another accord in light of the current dollar gain and the suffering it has created for other nations. However, the White House has rejected the notion, making it appear implausible at this time.
Brian Deese, the director of the National Economic Council, said on Tuesday, “I don’t anticipate that’s where we’re headed.
The Federal Reserve is anticipated to continue its current course in the interim. Thus, other central banks won’t be able to unwind as the dollar could yet rise further.
According to Ashley of Goldman Sachs Asset Management, increased dollar strength and higher US interest rates are “certainly something that we should be anticipating, and the repercussions of that are actually quite deep.”