Dollar surge leaves trail of destruction By Reuters

By Saikat Chatterjee and Sujata Rao

LONDON (Reuters) – The dollar’s race to two-decade highs is leaving a trail of destruction in its wake, exacerbating inflation in other countries and tightening financial conditions just as the world economy confronts the prospect of a slowdown in growth.

This year’s 8% gain against a basket of currencies is driven partly by bets that the U.S. Federal Reserve will raise interest rates faster and further than other developed countries, and partly by its status as a safe haven in times of turbulence.

It is also supported by Japan’s reluctance to ditch its super-easy policies, and fears of recession in Europe.

Here are some areas affected by the dollar’s muscle-flexing:

Graphic: FX returns this month – https://fingfx.thomsonreuters.com/gfx/mkt/zgpomlzrypd/Fx%20returns1.JPG

1/EXPORTS

Currency weakness normally benefits export-reliant Europe and Japan, but the equation may not hold when inflation is high and rising.

Euro zone inflation hit a record 7.5% this month, although so far European Central Bank policymakers blame it mainly on energy prices.

Bank of Japan boss Haruhiko Kuroda still views yen weakness as a positive for Japan, but lawmakers fret that the yen, at 20-year lows, will inflict damage via costlier food and fuel. Half of Japanese firms expect higher costs to hurt earnings, a survey found.

2/ TIGHTENING BECOMING FRIGHTENING

A rising U.S. dollar tends to tighten financial conditions, which reflect the availability of funding. Goldman Sachs (NYSE:) estimates that a 100 bps tightening in its widely used proprietary Financial Conditions Index (FCI) crimps growth by one percentage point in the following year.

The FCI, which factors in the impact of the trade-weighted dollar, shows global conditions at their tightest since 2009. The FCI has tightened by 120 basis points in April alone, as the dollar has strengthened 5%.

Emerging markets tend to have especially high levels of dollar debt. EM conditions have tightened 190 basis points this month, led by Russia, Goldman’s FCI shows.

The U.S. FCI is at its tightest since July 2020.

“It has got to be concerning, given everything else that’s going on. This is just the time you don’t want too much tightening of conditions,” said Justin Onuekwusi, portfolio manager at Legal & General Investment Management.

Graphic : Borrowing costs – https://fingfx.thomsonreuters.com/gfx/mkt/egvbkeqnzpq/borrowing%20costs.JPG

3/ THE EMERGING PROBLEM

Almost all past emerging market crises were linked to dollar strength. A 10.5% jump in 1993 followed by a 4.6% rise in 1994 for instance were blamed for triggering the “Tequila crisis” in Mexico, which was followed by meltdowns in emerging markets in Asia, as well as Brazil and Russia.

Dollar strength means higher revenues in local currencies for commodity-exporting developing countries. But the…