Cooling U.S. Inflation Drives Decline in Dollar, Boosting Risk Assets Globally
NEW YORK, July 14 (Reuters) – The declining U.S. inflation is causing a fall in the dollar, benefitting risk assets around the world. The dollar has decreased by almost 13% against a basket of currencies since its two-decade high last year, currently standing at its lowest level in 15 months. The decline in the dollar accelerated after the U.S. reported weaker-than-expected inflation data on Wednesday, suggesting that the Federal Reserve is approaching the end of its interest rate-hiking cycle.
The impact that the weakening dollar has on the global financial system means that a wide range of assets can benefit if the decline continues. A weaker dollar can benefit some U.S. companies, making their exports more competitive abroad and cheaper for multinationals to convert their foreign profits back into dollars. The U.S. technology sector, which has led markets higher this year, generates just over 50% of its revenues overseas.
Additionally, a falling dollar makes raw materials priced in dollars more affordable to foreign buyers, boosting commodities. The S&P/Goldman Sachs Commodity Index is up 4.6% this month, set to achieve its best month since October. Emerging markets also benefit as a weaker U.S. currency makes dollar-denominated debt easier to service. The MSCI International Emerging Market Currency Index is up 2.4% this year.
Alvise Marino, a foreign exchange strategist at Credit Suisse, stated, “For markets, the weaker dollar and its underlying driver, weaker inflation, is a balm for everything, especially for assets outside the U.S.”. The decline in the dollar is also attributed to the easing U.S. Treasury yields in recent days, diminishing the dollar’s appeal while boosting a range of other currencies.
The falling dollar could be profitable for foreign exchange strategies like the dollar-funded carry trade. By selling dollars to buy higher-yielding currencies, investors can profit from the difference. The dollar’s decline has already made this strategy profitable this year, with currency data from Corpay showing returns of 25% and 13% for selling dollars and buying the Colombian peso and Polish zloty, respectively.
On the monetary policy front, the decline in the dollar could bring relief to some countries, reducing the need for them to support their weakening currencies. Japan, for example, has seen the dollar fall 3% against the yen this week, the largest weekly decline since January. Traditionally, yen weakness has negatively impacted Japan’s import-reliant economy, raising expectations for intervention to support the yen. Similarly, Sweden’s central bank has been watchful for signs of action as the dollar has fallen almost 6% against the krona this week, the biggest weekly drop since November.
Currency strategists have warned of potential risks associated with being bearish on the dollar, such as a potential rebound in U.S. inflation leading to increased bets on more aggressive Federal Reserve moves. However, Helen Given, an FX trader at Monex USA, believes that the Fed will wrap up its rate-hiking cycle before most other central banks, limiting the dollar’s long-term momentum. She expects the dollar to be even weaker in six months’ time.
Reporting by Saqib Iqbal Ahmed; Additional reporting by Dhara Ranasinghe and Ira Iosebashvili; Writing by Ira Iosebashvili; Editing by Leslie Adler