The Federal Reserve is laser-focused on stemming price increases in the United States. But countries thousands of miles away are reeling from its hardball campaign to strangle inflation, as their central banks are forced to hike interest rates faster and higher and a runaway dollar pushes down the value of their currencies.
“We’re seeing the Fed being as aggressive as it has been since the early 1980s. They’re willing to tolerate higher unemployment and a recession,” said Chris Turner, global head of markets at ING. “That’s not good for international growth.”
The Federal Reserve’s decision to raise rates by three-quarters of a percentage point at three consecutive meetings, while signaling more large hikes are on the way, has pushed its counterparts around the world to get tougher, too. If they fall too far behind the Fed, investors could pull money from their financial markets, causing serious disruptions.
Central banks in Switzerland, the United Kingdom, Norway, Indonesia, South Africa, Taiwan, Nigeria and the Philippines followed the Fed in boosting rates over the past week.
The Fed’s stance has also pushed the dollar to two-decade highs against a basket of major currencies. While that’s helpful for Americans who want to go shopping abroad, it’s very bad news for other countries, as the value of the yuan, the yen, the rupee, the euro and the pound tumble, making it more expensive to import essential items like food and fuel. This dynamic — in which the Fed essentially exports inflation — adds pressure on local central banks.
“The dollar doesn’t strengthen in isolation. It has to strengthen against something,” said James Ashley, head of international market strategy at Goldman Sachs Asset Management.
The punishing consequences of the rapid appreciation of the dollar have become clearer in recent days. Japan intervened last Thursday for the first time in 24 years to shore up the yen, which has plunged 26% against the dollar year-to-date. (The Bank of Japan has remained an outlier among major central banks and has resisted hiking rates despite an uptick in inflation.)
China is watching currency markets after the yuan trading onshore slid to its lowest level against the dollar since the global financial crisis, while European Central Bank President Christine Lagarde warned Monday that the euro’s sharp depreciation has “added to the build-up of inflationary pressures.”
The United Kingdom shows just how quickly the situation can spiral out of control as global investors choked on a new government’s economic growth plan. The British pound fell to a record low against the dollar on Monday after the unorthodox experiment of implementing large tax cuts while boosting borrowing triggered alarm.
The ensuing chaos forced the Bank of England to announce an emergency bond-buying program to try to stabilize markets, and led to an admonishment from the International Monetary Fund, which said the UK government should reconsider its proposals.
The global financial system is “like a pressure cooker” right now, Turner said. “You need to have strong, credible policies, and any policy missteps are punished.”
The threat to emerging markets
The World Bank recently cautioned that the risk of a global recession in 2023 has risen as central banks across the world hike interest rates at the same time in response to inflation. It also said the trend could result in a series of financial crises among developing economies — many still reeling from the pandemic — “that would do them lasting harm.”
The biggest fallout may be felt in countries that have issued debt denominated in dollars. Paying back those obligations becomes more expensive as local currencies depreciate, forcing governments to cut back spending in other areas just as inflation savages living standards.
Waning currency reserves is also cause for concern. A shortage of dollars in Sri Lanka has contributed to the worst economic crisis in the country’s history and forced its president out of office earlier this year.
The risks are laid bare by the size of interest rate hikes in many of these countries. Brazil, for example, kept interest rates steady this month, but only after 12 consecutive increases that left its benchmark rate at 13.75%.
Nigeria’s central bank hiked rates to 15.5% on Tuesday, much higher than economists had expected. In a statement, the central bank noted that “ongoing monetary policy tightening by the US Federal Reserve Bank is also putting upward pressure on local currencies across the world, with pass-through to domestic prices.”
Can the pain be stopped?
The last time the dollar went on a similar tear, in the early 1980s, policymakers in the United States, Japan, Germany, France and the United Kingdom announced a coordinated intervention in currency markets that became known as the Plaza Accord.
The dollar’s recent rally, and the ensuing pain it’s caused for other countries, has sparked chatter that it may be time for another agreement. But the White House has thrown cold water on the idea, which makes it look unlikely for now.
“I don’t anticipate that that’s where we’re headed,” Brian Deese, the director of the National Economic Council, said Tuesday.
In the meantime, the Federal Reserve is expected to stay the course. That means the dollar could yet climb further, and other central banks won’t be able to relax.
Additional dollar strength and higher US rates is “absolutely something that we should be anticipating, and the consequences of that are really quite profound,” Ashley of Goldman Sachs Asset Management said.