The Dollar (Wrecking Ball)

The US dollar is easy to overlook sometimes. After all, there have been calls for its demise for years. It seems as though every few years the reserve currency status of the dollar is under threat from somewhere. The Japanese Yen was a possibility a couple decades ago. Then (laughably) the euro. 

But the dollar has yet to be unseated. And that might have some consequences for investors. 

It is worth noting that the yen has depreciated markedly against the dollar recently. But the dollar has also surged versus the euro, pound, and the yuan. 

When the dollar strengthens, it has consequences too. Dollar strength is synonymous with importing disinflationary pressures. This time will take more time given the China lockdown driven supply chain dislocations. All else equal though, the strength in the dollar is disinflationary

Disinflationary does not mean lower inflation comes quick though. 

In retrospect, the Fed got a bit lucky with the “taper tantrum”. Not in terms of it really helping with being able to raise rates (it nearly broke the global economy), but in terms of inflation pressures. 

Remember the great inflation of the mid-2010’s? That’s because it did not happen. 

This time is different. Will the dollar be the inflation killer it has been in the past? 

Probably not. 

There are numerous reasons. But the most intriguing is the fact that this is not inflation the Fed can control without killing demand. Normally, a strong dollar puts pressure on emerging markets buying goods in dollar terms. That dynamic has not changed. But the US is in a difficult spot when it comes to the ability to import disinflation. The combination of China lockdowns destroying supply chains and higher commodity prices across the board are the culprits. 

Those are not going to dissipate in the near-term.

Even the release of tens of millions of barrels of oil had a marginal effect on the price of gasoline. And that is with a very strong dollar. What really matters is where prices and the economy go from here. That is not a straightforward query. 

Will prices stop going up? At some point, yes. But the dollar is less of a wrecking ball than it usually is in these circumstances. Without the dollar to do the heavy lifting, the Fed might feel the need to get overly aggressive. That usually does not end well. 

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