Amid renewed concerns about inflation and above-average economic growth.
Written by Wolf Richter of Wolf Street.
dollar index [DXY] The index, which pegs the U.S. dollar against a basket of six currencies dominated by the euro and yen (euro, yen, Canadian dollar, British pound, Swedish krona and Swiss franc), has so far risen to 107.6, its highest level in two years. It became.
Interest rates have risen 7.3% in the past two months since the Fed began cutting back on the pace of rate cuts at a ferocious pace.
Since late September, the US dollar has been on a rampage against other currencies. After the Fed's monster rate cut on September 18th, it became clear that it would reduce the size and frequency of rate cuts to end at higher levels than previously priced in. That's when we started talking. After all, the U.S. labor market is growing steadily, inflation is showing early signs of reaccelerating, and economic growth is driven primarily by consumers whose incomes have increased significantly in recent years and That's well above my 15-year average, and I've saved a lot. Also, I have a growing pile of interest-earning cash that I can use in the future.
And this happened while other central banks (here the ECB, Bank of Japan, Bank of Canada) far outperformed the Fed.
- The Fed lowered its policy rate ceiling by 75 basis points to 4.75%.
- The ECB cut the rate by 100 basis points (bp) to 3.4%, indicating it intends to continue lowering the rate even as services inflation remains high and wages are rising sharply.
- The Bank of Canada lowered the rate by 125 basis points to 3.75% and indicated that it intends to continue lowering it going forward.
- Despite an inflation rate similar to that of the United States, the Bank of Japan raised interest rates by just two steps, from negative to +0.25%, and the real yield on government bonds became significantly negative. He said it was in a recession before, but could rise again.
The spread between the policy rate and the Fed's policy rate has widened due to the ECB and BOC rate cuts. And now that spread is expected to widen even further.
U.S. dollar-denominated securities such as Treasury bills have much higher yields, making them easy targets for foreign investors, who load them on the back of trucks. This demand for USD-denominated securities and the expected higher yields in the future provide significant support for the USD exchange rate.
This is clear when you look at the 10-year yield on government bonds.
- USA: 4.41%
- Canada: 3.46%
- Germany: 2.25%
- Japan: 1.08%.
The euro fell 7.0% against the US dollar. It is trading at $1.042 today, its lowest since late September, and its lowest since November 2022.
The euro area economy is growing slowly, with growth stagnant in some countries. Germany has oscillated between modest growth and slight decline every quarter for the past two years. GDP in 2023 is down a bit, but 2024 is similar so far. The ECB said it would continue cutting interest rates despite concerns about core inflation, particularly persistently high services inflation. And the euro will plummet.
The Canadian dollar has been depreciating all year. Rates are being cut against the US dollar as the BOC focuses on cutting rates. Economic growth slowed sharply in 2023. Over the past seven quarters, economic growth has been negative in two quarters and nearly flat in one quarter. The rest showed moderate growth. GDP growth accelerated slightly in the first half of this year. GDP figures for the third quarter have not yet been released.
By the end of last week, the Canadian dollar had fallen to US$0.709, its lowest since June 2020. It has now risen slightly from there and is trading at USD 0.715. It has fallen 3.7% since late September. It has fallen 5.5% since mid-January.
The Bank of Japan is in a category of its own, crushing currencies.. Inflation in Japan is progressing at a similar pace to the United States. However, the Bank of Japan has vowed to implement the absolute minimum measures as slowly as possible, and it is already too little too late. It finally ended QE earlier this year and began QT a few months ago, slowly shrinking its huge balance sheet. This “too late, too early” attitude has been going on for two years, and the Yen has been slaughtered as a result.
The yen is currently trading at 154.7 yen to the dollar, returning to the level seen in July, when it plummeted to 161.5 yen to the dollar.
Rather than change monetary policy to prevent a mass carnage of currencies, the authorities are trying to water down the market, which is essentially useless except for day traders. And while the authorities have regularly spent tens of billions of dollars to buy the yen, these costly efforts to prop up the yen only last for a short period of time before the yen plummets again, as you can see in the graph. It had no effect.
Since the Fed started talking about rate hikes in September 2021, the yen has fallen 30% against the US dollar.
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