The Federal Reserve is focused on curbing price increases in the United States. But countries thousands of miles away are reeling from their grueling campaign to strangle inflation as their central banks are forced to raise interest rates faster and higher and a runaway dollar pushes the value of their currencies down.
“We see that the Fed is as aggressive as it has been since the early 1980s. They are prepared to tolerate higher unemployment and a recession,” said Chris Turner, Global Head of Markets at ING. “That is not good for international growth.”
The Federal Reserve’s decision to raise interest rates by three-quarters of a percentage point on three consecutive meetings while signaling that more major rate hikes are on the way has prompted its counterparts around the world to tighten up as well. If they lag too far behind the Fed, investors could take money out of 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 raising interest rates last week.
The Fed’s stance has also pushed the dollar to a two-decade high against a basket of major currencies. While that’s convenient for Americans looking to shop abroad, it’s very bad news for other countries, as the value of the yuan, yen, rupee, euro and pound falls, making it more expensive to buy essential items such as import food and fuel. This dynamic – with the Fed essentially exporting inflation – is putting more pressure on local central banks.
“The dollar is not getting stronger in isolation. It has to get stronger against something,” said James Ashley, head of international market strategy at Goldman Sachs Asset Management.
The punitive consequences of the dollar’s rapid appreciation have become more apparent in recent days. Japan intervened last Thursday for the first time in 24 years to support the yen, which has fallen 26% against the dollar so far. (The Bank of Japan has remained an outlier among major central banks, resisting rate hikes despite a rise in inflation.)
China is watching currency markets after onshore trading in the yuan plunged to its lowest level against the dollar since the global financial crisis, while European Central Bank president Christine Lagarde warned on Monday that the sharp depreciation of the euro “contributed to the build-up of inflationary pressures. ”
The UK shows how quickly things can spiral out of control if global investors choke 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 major tax cuts and loan boosting sounded the alarm.
The ensuing chaos forced the Bank of England to announce an emergency bond-buying program to try to stabilize markets, and prompted an admonition from the International Monetary Fund, which said the British government should rethink.
The global financial system is “like a pressure cooker,” Turner said. “You have to have a strong, credible policy and any policy misstep will be punished.”
The World Bank recently warned that the risk of a global recession in 2023 has increased as central banks around the world simultaneously raise interest rates in response to inflation. It also said the trend could lead to a series of financial crises in emerging economies — many still reeling from the pandemic — “that would cause them lasting damage.”
The greatest impact can be felt in countries that have issued debt in dollars. Paying back those obligations becomes more expensive as local currencies depreciate, forcing governments to cut spending in other areas, just as inflation undermines living standards.
Declining currency reserves are also a cause for concern. A dollar shortage in Sri Lanka contributed to the worst economic crisis in the country’s history and forced the president out of office earlier this year.
The risks are exposed by the magnitude of the rate hikes in many of these countries. Brazil, for example, kept interest rates stable this month, but only after 12 consecutive hikes did the benchmark stay at 13.75%.
Nigeria’s central bank raised interest rates to 15.5% on Tuesday, much higher than economists had expected. In a statement, the central bank noted that “the continued tightening of monetary policy by the US Federal Reserve Bank is also putting upward pressure on local currencies around the world, with spillovers into domestic prices.”
The last time the dollar made a similar rift, in the early 1980s, policymakers in the United States, Japan, Germany, France and the United Kingdom announced a coordinated intervention in the foreign exchange markets that became known as the Plaza Accord.
The dollar’s recent rally, and the resulting pain it causes for other countries, has sparked rumors that it may be time for a new deal. But the White House has given the idea cold water, making it look unlikely for now.
“I don’t expect us to go there,” Brian Deese, the director of the National Economic Council, said Tuesday.