The US dollar a.k.a. the greenback a.k.a. the "buck" has firmed its grip as "king of the FX world" so far this year. The benchmark dollar index (DXY), which measures how the USD has performed against a basket of major peers such as the euro, pound, and yen, has climbed by more than 3.3% so far in 2022 and is trading around its highest levels since May 2020. The buck also has a year-to-date advance against most of its G10 peers and all Asian currencies.
So why has the dollar been so strong?
Here are 3 reasons
The Fed is raising interest rates
A country’s currency tends to climb alongside its interest rates. Last week, the US central bank raised interest rates by 25 basis points for the first time since December 2018. More importantly, the Fed indicated that it could raise rates another six times for the rest of this year, even citing the possibility of a 50-basis point hike in May. That would be like firing two bullets with a single shot. As markets anticipate these higher rates, that has sent the US dollar upwards as well.
Despite interest rates going up (which typically translates into slower economic growth), the US economy is expected to fare better than its major peers, namely the European Union (which has an all-out war raging off to its east) and the United Kingdom. For example, the US is less reliant on Russia for oil and natural gas, compared to the EU and the UK. The Bank of England is already starting to pour cold water on how much it could raise interest rates, sounding more 'dovish' after its policy meeting earlier this month. The European Central Bank is still pressing ahead with its plans to raise interest rates, but markets are doubting its how much the ECB can hike, considering the potential fallout from its worst security crisis since World War 2. Noting that the euro and the British Pound account for almost 70% of the DXY, the US economy’s relative outperformance compared to the EU and the UK should keep the DXY well supported.
Safe haven demand
The US dollar is seen as an asset that can protect investors’ wealth when markets are facing heightened fears. In times of great uncertainty the US dollar welcomes investors far and wide with arms wide open. After all, the greenback is the world’s reserve currency, is mostly widely used in cross-border transactions, and is the currency of the world’s largest economy. However, that doesn’t mean that the US dollar is climbing against every single currency.
In fact, within the G10 space, the US dollar has weakened against these four currencies thus far in 2022:
- Australian dollar (AUD): 3.2%
- Norwegian krone (NOK): 2.5%
- New Zealand dollar (NZD): 1.9%
- Canadian dollar (CAD): 0.7%
(percent figures reflect currency's year-to-date performance against the US dollar)
And here are two main reasons why the above-listed currencies have strengthened against the greenback:
- Their central banks have also raised interest rates, except for the Reserve Bank of Australia, for now.
- More influential is the fact that markets believe that these central banks are ready to raise rates even higher in order to bring down roaring inflation.
These economies are reliant on commodities. Given the surge in commodities in recent months, companies in these countries, along with the governments, stand to earn more money. More money flowing into its economy = more demand for its currency = currency strength
The same rationale also applies to currencies like the Brazilian Real, which is the best-performing emerging-market currency against the US dollar so far this year. Overall, the US dollar is expected to maintain its position of strength throughout the course of 2022 and potentially beyond.
Though as explained above, not all currencies are created equal, which means there are a number of currencies that still stand to outperform ‘king dollar’ this year.