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The US dollar has surged in 2022, with higher interest rates, a more hawkish central bank, stronger economic outlook and global safe-haven flows all fueling its ascent.
A weaker dollar would ease financial conditions and allow global risk to pick up.
However, it would likely take both an improving global growth outlook, particularly relative to the US, and a period of Federal Reserve rate cuts for that to happen.
It is reasonable to suggest that this bull will likely continue into 2023.
In the current context of economic and geopolitical uncertainty, the US Dollar has posted strong returns in 2022, propelling the US Dollar Index (DXY) to levels not seen in over 20 years.
Since the beginning of the year, it is up 13% against the euro, 17% against the pound sterling and 22% against the yen. This has important implications for international portfolios and, being the world’s reserve currency, also for global financial conditions.
So what drives the dollar higher?
Recognizing domestic vulnerabilities, some central banks have recently slowed their pace of rate hikes, unlike the inflation-only Federal Reserve (Fed), which is now expected to raise rates above 5%.
Consequently, higher interest rates in the United States continued to attract global capital flows in search of higher yields.
As global economic risks continue to emerge, the dollar will likely continue to be seen as the best safe haven to withstand growth setbacks in Europe and Asia.
While a dollar spike may come when the Fed eventually slows its monetary tightening path, that alone may not be enough to trigger a substantial dollar depreciation.
In the past, it has also taken an improvement in global growth prospects to cause a reversal in the dollar.
Therefore, while the dollar’s valuation remains stretched, the engines of its strength have not yet been exhausted.
Investors can expect the dollar’s surge to continue through 2023.