Rising Dollars Hurt Other Currencies Central Banks Intervene

by Wall Street Rebel - Michael London | 10/27/2022 3:37 PM

Foreign central banks are compelled to stabilize their local currencies due to the Federal Reserve's interest rate increases, causing international market anxiety.

The Federal Reserve has been increasing interest rates rapidly, which has slanted the playing field in favor of the dollar. Governments worldwide have been working to stabilize their currencies and protect their economies from these rate hikes. Their actions shed light not just on the interconnectedness of the global financial system but also on the vulnerabilities that exist within it.

As a result, the currencies of other countries valued relative to one another have plummeted, unnerving markets in some of the world's largest economies, including Japan, China, India, and Britain.

According to Principal Asset Management's senior global strategist Seema Shah, the Federal Reserve "is supercharging the U.S. dollar, limiting the ability of other global central banks to manage their economies adequately." This statement was stated in response to the Federal Reserve's policy of enhancing the dollar's worth.

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The economic impact of the Fed's actions on other regions is partial. A weakened currency increases the cost of importing food, energy, and other products. This increases domestic inflation, harms households, and may contribute to a worldwide economic recession.

The rise in the dollar's value has also made it more difficult for international borrowers to repay debts denominated in U.S. currency. The rates on foreign sovereign bonds, which reflect the cost of borrowing for foreign governments, have climbed as investors have transferred funds from their home nations to the United States.

But there is another problem that investors and governments are concerned about. The prices of assets located worldwide are linked to one another, thanks to the connectivity of global markets. As a result, higher interest rates in the United States have caused significant movements in international currencies, bonds, and stocks, which in turn has caused markets to respond abruptly and simultaneously.

The turmoil seen on global financial markets is a difficulty for the decision-makers in the United States: Inflation is excessive and needs to be tamed, but the answer, which is sharp increases in interest rates, is starting to disrupt the financial system to the point that some analysts say it could snowball into a catastrophic spell of instability. However, there is little indication that the Fed is interested in making a rapid course adjustment. It is anticipated that it will hike rates more the following week and boost them even further later this year and into 2023.

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Central banks store reserves of foreign currencies and bonds in their vaults as a form of financial insurance against the possibility of a rapid or unpleasant decline in the value of their nation's currency. These reserves are often denominated in significant international currencies such as the United States dollar, Great Britain's pound, the euro, and other such currencies. Consequently, several centralized banks have started taking measures to boost the value of their respective national currencies.

This year, these reserves have decreased as a result of the decrease in the value of most currencies, with the exception of the dollar, which has remained relatively stable in value. The sale of dollars by countries to purchase back their own currencies in an effort to prop them up has also led to a drop in reserve holdings. This is done in an effort to prop up the value of the countries' own currencies. Bond prices have fallen due to rising interest rates, which have allowed investors to locate other investments with greater yields. This has led to increased competition among investors for these higher-yield investments.

Because accurate data is difficult to come by and varies from country to country, it is impossible to determine the full amount to which governments intervene in the currency markets of different countries throughout the world.

The Japanese government made its first move of this kind since 1998 when, in September, it spent roughly $20 billion buying its own currency to halt the rapid slide of the yen's value. The measure was stated by analysts to have lessened some of the volatility in the market, but the impacts of the action were said to have been short-lived, and the currency has continued to decline since then.

Before making a sudden, significant recovery, the value of one dollar in the Japanese yen reached its lowest point against the dollar since records began being kept in 1990. This marked a decline of more than 23 percent for the year. Traders began to speculate that the government had again intervened due to this development. The statement has not been substantiated by an official statement from the Japanese government.

Countries including South Korea, Taiwan, the Philippines, Vietnam, Malaysia, and Thailand have all come clean about their involvement in currency manipulation.

India's central bank has been selling its reserves of dollars and buying back rupees since March. In the year through August, it bought back $43 billion of rupees. Its currency has fallen roughly 10 percent against the dollar this year.

Since the beginning of March, the Reserve Bank of India has started liquidating its dollar holdings to repurchase Indian rupees. It repurchased 43 billion rupees over the course of the previous year up until August. This year, the value of its currency has decreased nearly 10 percent when measured against the dollar.

According to Brad Setser, a senior fellow at the Council on Foreign Relations and a former adviser to the Biden administration, most nations that have interfered with halting the drop in their currencies have only successfully reduced the rate at which it is occurring. According to Mr. Setser, "it has been very difficult to stop the pressure that the Fed's hikes have created."

Officially, China has not yet directly intervened to protect its currency despite a gentle depreciation. Even though the yuan has been depreciating, China has not done so because of the strength of the yuan. This is because the yuan is strong compared to other Asian currencies and because the government has established national bank policies that are meant to support the yuan's value.

There is a possibility that countries will start selling Treasuries in a more aggressive manner as their foreign reserve balances continue to decline. While many countries have been intervening by utilizing their cash reserves, others have been selling bonds the United States government issued. According to bankers, China, Japan, and India have all sold Treasuries over the past few weeks to help maintain their respective currencies.

When foreign investors sold large amounts of Treasuries in the year 2020, the price of U.S. government bonds gyrated, prompting investors to dump their own holdings of Treasury bonds quickly. This occurred because a set of highly leveraged bets based on typical pricing patterns unexpectedly went bad. As foreign officials and hedge funds sold Treasuries, normal trading broke down, forcing the Fed to buy bonds at a tremendous scale to restore proper functioning in the world's most important debt market.

The issue that needs to be answered for the United States is whether or not a strengthening dollar will bite them back by reducing the demand for debt issued by the American government. This can happen in two ways: it will force more people to sell their Treasuries or leave the market with fewer buyers. It is already more difficult than usual to find buyers for U.S. bonds, and the possibility of a pullback by investors representing foreign governments might worsen the situation.

After a proposal for a government spending and tax cut that unnerved investors, the bond market in Britain has already been through a round of extreme dysfunction, one that compelled the Bank of England to intervene temporarily in the market. Even though the reason for the breakdown was an isolated incident, some people saw the episode as evidence that conditions are so precarious that they are likely to fail at the first sign of difficulty. The proposal caused this.

Other bond markets have started to show signs of instability as well. Concerned about a potential shortage of credit, South Korea has increased the amount of corporate bonds it is willing to purchase through state banks by a factor of two.

In contrast to the majority of its counterparts throughout the world, the Bank of Japan continues to maintain its commitment to maintaining historically low-interest rates even as it works to stimulate inflation. However, it won't be easy to adhere to this policy as long as the Fed continues to raise interest rates. This will not only put pressure on the U.S. dollar but also increase the cost of borrowing money, which would cause yields on Japanese bonds to rise.

Recently, the Bank of Japan increased the purchases of its own government bonds to maintain historically low bond yields. However, due to the government's massive holdings, there have been times when days have gone by without any trade involving the government's debt, which is a sign of the fragile state of the market.

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There is also an additional danger. Even though Japan is still dedicated to maintaining low-interest rates, at least for the time being, market speculation suggests that it may begin to allow domestic yields to rise the next year, which would attract Japan's domestic investors away from the United States. Because Japanese investors have traditionally been significant buyers of Treasury bonds, this would be significant for markets in the United States and worldwide.

The United Nations has issued a demand for increased global coordination among central banks to avert the negative effects of rising interest rates on economies worldwide. However, national central banks are only accountable for their own economies and not those of other countries.

The turmoil plaguing the world's financial markets is not likely to abate before the end of the year.