This year, political and economic instability has prompted investors to flock to the dollar, particularly following turmoil in South Korea that weakened the won. Concerns over potential U.S. tariffs have also impacted currencies like the yuan. Despite challenges in major economies, the dollar has seen a modest increase against global currencies, bolstered by a cautious Federal Reserve. However, maintaining its strength may be difficult if other currencies begin to recover.
Investor Shift Towards the Dollar Amidst Global Turmoil
This year, unexpected political and economic developments have driven investors to seek refuge in the dollar. A prime example is the recent political upheaval in South Korea, which caused the won to plummet to its lowest point in two years, nearly marking its worst trading day in eight years.
While the won ranks as the twelfth most traded currency globally, making up just 2% of daily foreign exchange transactions, South Korea’s position as the fourth-largest economy in Asia gives this volatility significant weight. The turmoil in its foreign exchange and stock markets has led to emergency actions by Seoul to ensure financial stability, casting a shadow over the outlook for emerging markets as a whole.
Challenges for Emerging Markets and the Dollar’s Ascendancy
Asia, in particular, is grappling with growing concerns about potential tariffs from the newly inaugurated U.S. President, which has further devalued the Chinese yuan, pushing it to its lowest level this year.
At the start of the year, few analysts could have predicted the imposition of martial law in South Korea or the anemic growth facing the eurozone, characterized by Germany’s economic challenges and political strife in France. Additionally, China’s struggle with potential deflation, sluggish growth in Canada prompting significant interest rate cuts in the G7, a Japanese yen at a 33-year low, and fears over Brazil’s budget have all contributed to a precarious economic landscape.
Many market observers argue that currency trading is inherently a zero-sum game, where prices are relative. However, 2024 has proven particularly advantageous for the dollar, driven by unique political dynamics and economic weaknesses impacting both developed and major emerging market currencies.
The adage that the dollar is the ‘cleanest dirty shirt’ among global currencies has been validated by recent events. This year, the dollar index has seen only a 5% increase against its G10 counterparts, despite the U.S. tightening its grip on global stock markets. International investors have poured unprecedented sums into U.S. equities, while American investors have predominantly remained domestic.
Moreover, the Federal Reserve’s cautious approach to interest rate cuts has provided an unexpected lift to the dollar, contrasting with earlier market predictions of significant rate easing. At the year’s outset, futures markets anticipated a reduction of about 150 basis points in 2024, a scenario that has not materialized.
With the eurozone, Canada, and other major economies facing their own challenges, this 5% increase in the dollar’s value seems less remarkable in context. Although the dollar has gained against many emerging market currencies, these represent a smaller fraction of its overall value.
The pressing question for the future is whether the dollar can maintain its strength based on its own merits. While it’s difficult to envision significant recoveries in the eurozone, China, or other major economies that might counter the dollar’s dominance, the greenback’s current standing at a 20-year high poses challenges for continued appreciation. Especially if other global currencies begin to gain traction.
(The views expressed in this article are those of the author, a columnist for Reuters.)