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(Bloomberg) – The soaring dollar is pushing the global economy deeper into a synchronized slowdown by driving up borrowing costs and stoking financial market volatility – and there’s little respite on the horizon.

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A closely watched gauge of the greenback has risen 7% since January to a two-year high as the Federal Reserve embarks on an aggressive series of interest rate hikes to curb inflation and investors bought dollars as a safe haven in times of economic uncertainty.

A rising currency should help the Fed cool prices and support U.S. demand for goods from abroad, but it also threatens to push up the prices of imports from foreign economies, further stoking their interest rates. inflation and deprive them of capital.

This is particularly worrying for emerging economies, which are forced to either let their currencies weaken, intervene to cushion their fall, or raise their own interest rates in a bid to bolster their exchange rate levels. .

India and Malaysia made surprise rate hikes this month. India has also entered the market to support its exchange rate.

Advanced economies were not spared either: last week the euro hit a new five-year low, the Swiss franc weakened to parity with the dollar for the first time since 2019 and the Hong Kong Monetary Authority was forced to intervene to defend its monetary parity. The yen also recently hit a two-decade low.

“The rapid pace of Fed rate hikes is causing headaches for many other economies around the world, triggering portfolio outflows and currency weakness,” said Tuuli McCully, Asia Pacific chief economics officer. at Scotiabank.

While the combination of slowing US growth and an expected slower US inflation will ultimately slow the dollar’s ascent – ​​which in turn will relieve other central banks to tighten – it will take maybe months to find this new balance.

So far at least, traders are hesitant to call a spike in the dollar rally. This partly reflects bets at the end of 2021 that the greenback’s gains would fade as rate hikes were already priced in. These opinions have since been shredded.

According to Clay Lowery, former U.S. Assistant Secretary of the Treasury for International Affairs, developing economies are threatened by a “currency mismatch,” which occurs when governments, corporations, or financial institutions have borrowed in U.S. dollars and lent in their local currency. now Executive Vice President of the Institute for International Finance.

Global growth will essentially stagnate this year as Europe slips into recession, China slows sharply and financial conditions in the United States tighten significantly, according to a new forecast from the IIF. Morgan Stanley economists expect growth this year to be half that of 2021.

As rates continue to rise amid continued global volatility – from war in Ukraine to Covid lockdowns in China – it has led investors to rush for safety. Economies with current account deficits are likely to be more volatile.

“The United States has always been a safe haven,” Lowery said. “With Fed interest rates and market rates rising, even more capital could flow into the United States. And that could be detrimental to emerging markets.

Outflows of $4 billion were seen in emerging market securities in April, according to the IIF. Emerging market currencies have fallen and emerging Asian bonds have suffered losses of 7% this year, more than the hit received in the 2013 crisis.

“The tightening of US monetary policy will have significant spillovers to the rest of the world,” said Rob Subbaraman, head of global markets research at Nomura Holdings Inc. in the United States itself.

Many manufacturers say the high costs they face mean they don’t get much dividend from weaker currencies.

Toyota Motor Corp. forecast a 20% drop in operating profit for the current fiscal year despite robust annual car sales, citing an “unprecedented” rise in logistics and raw material costs. He said he doesn’t expect the weakened yen to produce a “major” improvement.

The Chinese yuan fell as record inflows of capital withdrew from the country’s financial markets. For now, it remains shielded from the broader dollar effect as low inflation in the country allows authorities to focus on supporting growth.

But this creates a new source of fragility for developing countries accustomed to a strong yuan providing an anchor for their markets.

“The renminbi’s recent abrupt change in trend has more to do with China’s deteriorating economic outlook than with Fed policy,” said Alvin Tan, strategist at Royal Bank of Canada in Singapore. “But it definitely broke the shield insulating Asian currencies from the rising dollar and precipitated the rapid weakening of Asian currencies as a group over the past month.”

In advanced economies, weakening currencies have created a “tricky political dilemma” for the Bank of Japan, the European Central Bank and the Bank of England, wrote Dario Perkins, chief European economist at TS Lombard in London, in a recent note.

Francois Villeroy de Galhau, a member of the ECB’s Governing Council, noted this month that “too weak a euro would run counter to our objective of price stability.”

“While domestic ‘overheating’ is primarily a US phenomenon, weaker exchange rates are adding to pressures on imported prices, keeping inflation well above central banks’ 2% targets,” Perkins wrote. “Monetary tightening could alleviate this problem, but at the cost of further domestic economic difficulties.”

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