A year ago, the dollar was approaching multi-decade highs as global currencies coped with the most aggressive FOMC hiking cycle of the last forty years.
In 2022, the widely tracked U.S. Dollar Index (DXY) peaked near 115 and closed the year at 104, representing a greater than 8 percent return on the year in what was broad-based dollar appreciation against global peers. All G10 currencies depreciated against the USD, with the euro notably falling below parity for the first time since 2002. U.S. dollar strength also extended across many emerging market currencies, as both the renminbi and rupee fell 7.9 and 10.1 percent, respectively. While relative interest rate differentials and risk sentiment drove U.S. dollar strength last year, the USD is flat year-to-date. As the domestic forward rate path becomes more defined, divergent global interest rate policies have driven both currency weakness and strength against the USD.
This chart of the month displays both 2022 and year-to-date price returns for all G10 currencies in addition to select emerging markets currencies. Last year’s U.S. dollar strength can be observed on the leftmost chart, as only the Mexican peso and Brazilian real posted positive returns. Conversely, the righthand chart shows how varied currency strength has been against the U.S. dollar this year. While some major developed market currencies such as the British pound, Swiss franc, and euro have gained resulting from expectations of further restrictive policy measures, this has not been monolithic as other key currencies such as the yen have fallen significantly1.
Among key emerging markets, there is a great deal of return dispersion. While the peso and real continue to be sources of strength, China’s stagnant reopening has led to currency weakness. In China, growth has slowed to a crawl as activity data continues to undershoot expectations. Additionally, financial turmoil has become a fear again as multiple large firms appear to be on the brink of failure. This resulted in a surprise cut in the policy rate by the People’s Bank of China on August 15th and further weakening of the renminbi. Continued fiscal and monetary support could further the decline of the renminbi and Chinese equity markets2.
In the case of Brazil and Mexico, high inflation in 2022 resulted in policy rates at 13.25 and 11.25 percent, respectively. Brazilian and Mexican policy rates reached 10-year highs relative to the Fed Funds rate in 2022. However, falling inflation and relatively high monetary policy rates in these countries have led to continued strong performance relative to the U.S. dollar. Ultimately, slowing growth, high inflation and idiosyncratic issues will weigh on many emerging currencies. One example, Turkey, has remained a cautionary tale for policy makers with rampant inflation (48 percent YoY), slowing growth and a rapidly degrading currency.
As the U.S. heads towards a potential interest rate pause or peak over the next year, global economies will continue to diverge from the synchronized tightening that defined 2022, further driving dispersion in cross-currency markets. Such disparities should provide opportunities for active managers to outperform, particularly in emerging markets where interest rate policies will be particularly volatile.
- Japan notably elected to phase yield curve control in late July in a move that has led to significant turmoil in home rate and currency markets.
- Currency divergence across regions influences equity market returns as well, particularly for institutional investors that deploy capital in indices that are quoted in USD terms rather than local currencies.
