Why the US dollar is at a crossroads

The greenback faces a long-term threat amid growing talk of a de-dollarisation of the international trading order

Conflict in Ukraine, post-Covid aftershocks and skyrocketing inflation made investors clamour for the security of the US dollar last year. Getty

The US dollar was rampant last year, spiking to a 20-year high as global investors sought safety from the world's troubles by piling into the number one financial safe haven.

Conflict in Ukraine, the post-Covid recovery and skyrocketing inflation made investors clamour for the security of the greenback.

It helped that the US Federal Reserve was hiking interest rates faster than any other major central bank in its fight against inflation, giving investors decent yields for the first time in more than a decade.

But nothing lasts forever, not even the strength of the US dollar. Its popularity peaked last autumn and it has been sliding ever since.

At its late September peak, €1 bought just 96 US cents. Today, it buys $1.11, a rise of more than 15 per cent.

The greenback has taken an even bigger hit from the resurgent British pound. Last September, £1 bought just $1.08 with parity in sight. Sterling recently topped $1.30, a rise of more than 20 per cent from peak to trough.

This may be the start of what could be a steep decline, with Bloomberg recently warning that the “dollar’s busted bull run has buyers calling an end of an era”.

The dollar is broken apparently – and there’s worse to come. That is pretty heady stuff but is there any truth in it and what does it mean for you?

The Fed stoked last year’s dollar strength by hiking its rate from just 0.25 per cent in February 2022 to 5.25 per cent today, the fastest tightening cycle in four decades.

It moved faster and further than rival central banks, says David Stritch, market and currency analyst at international transfers specialist Caxton.

“US interest rates were already at 4 per cent last November when the Bank of England was only at 3 per cent and the European Central Bank at a paltry 2 per cent,” he adds.

With US inflation falling to 3 per cent in June, the Fed’s work is almost done. Markets expect one final hike at this week’s Fed meeting to 5.5 per cent. By spring, it may be cutting rates instead.

In contrast, UK inflation was stubbornly high at 7.9 per cent in June and markets expect the BoE to carry on hiking rates from today’s 5 per cent to a peak of 5.75 per cent and possibly higher.

With eurozone inflation higher than expected at 5.5 per cent in June, the ECB’s 3.5 per cent benchmark rate is expected to peak at 4 per cent.

Investors can now see higher yields outside the US. They’re feeling braver, too, as markets should recover as borrowing costs peak and fall. Both are bad news for the dollar. Perversely, a global recession could be good news, by reviving the safe haven trade.

A weaker dollar would be a boon for emerging markets, which are loaded up on dollar-denominated debt and will see their interest payments plunge.

The MSCI Emerging Markets Index is up just 4.89 per cent in the year to June 30, well below the 15.09 per cent return on MSCI World. It could play catch up in the second half of the year.

Commodities priced in dollars will become cheaper to overseas buyers, driving demand for everything from oil to gold. The yellow metal is already up 15 per cent over the past year and there could be more to come.

US businesses may also benefit as exports will look better value. Your next iPhone may get cheaper. So will a week's holiday in Florida.

However, your booming US tech stocks certainly won't be worth as much, once the gains are converted into other currencies.

The falling dollar will hit the value of remittances by migrant workers in countries whose currencies are pegged to the dollar, notably in Middle Eastern countries Jordan, Oman, Qatar, Saudi Arabia and the UAE, says Zahir Moghal, chief executive at foreign exchange provider Delma Exchange.

“The UAE is a major source of remittances for countries like India, Pakistan and the Philippines, whose economies could suffer a negative impact,” he adds.

The weaker dollar could also drive inflation higher in the UAE, by pushing up the cost of imports as dollar-linked dirhams buy fewer goods and services, according to Mr Moghal.

Mohammad Bitar, group deputy chief executive of Al Ansari Financial Services, says: “The impact of a declining dollar on remittance flows will not be uniform across all markets; government policies, economic diversification and the stability of local currencies will influence the extent of the impact on remittance-dependent economies.”

The greenback also faces a long-term threat amid growing talk of a de-dollarisation of the international trading order.

The dollar’s reserve currency status gives the US political power as well as economic strength, which it has used to punish Russia for invading Ukraine.

India and China have reacted by trading with Russia in rupees and yuan instead, while China is looking to establish the yuan as an international currency and dollar challenger, particularly in commodities.

Dollar hegemony is built on the country's strong economy, powerful military and cutting-edge technology with artificial intelligence breaking new frontiers, says Daniel Doll-Steinberg, co-founder of active innovation hub EdenBase.com.

“The increasing weaponisation of the US currency settlement system is giving a strong incentive for some countries to look for alternative solutions to the dollar,” he adds.

Analysts have been predicting the demise of the dollar for a long time and with good reason, says Richard Flax, chief investment officer at digital wealth manager Moneyfarm.

Currencies like the euro and the yuan may become increasingly relevant for global trade, but the dollar is likely to remain the pre-eminent currency for some time to come

Richard Flax,
chief investment officer, Moneyfarm

“The dollar looks expensive on traditional measures like purchasing power parity, while the US runs both fiscal and current account deficits, often associated with currency weakness.”

It has the world's highest national debt at $31.4 trillion but gets away with it thanks to the “exorbitant privilege” of having the dollar as the world's reserve currency.

The rise of China suggests we may be moving towards a more multipolar world but Chinese financial markets are not yet as freely accessible, Mr Flax says.

He notes that the euro was supposed to replace dollar hegemony, but hasn’t.

The US debt may be scarily high but others are catching up and, while US politics look unstable, so does everywhere else.

“Currencies like the euro and the yuan may become increasingly relevant for global trade but the dollar is likely to remain the pre-eminent currency for some time to come,” Mr Flax says.

No other government bond market is large and liquid enough to replace the US, says Mike Hollings, a partner at private investment company Leifbridge.

“The US benefits from a robust capitalist system and a strong legal framework that supports a thriving private sector, fosters significant innovation and entrepreneurship and features a consumer base that appears more resilient than those in other Western economies,” he adds.

Talk of a broken dollar is overdone, Mr Stritch says.

“Rather than the end of the dollar era, it more than likely marks a return to normality.”