The 'King dollar' climbs as the Fed continues to raise interest rates

The US dollar is about to enter its third month of advances against its peers.

The dollar is on the verge of a third straight month of gains after reaching a 20-year high against peers, reflecting the world's leading economies' differing outlooks for interest rates and growth.

The dollar index, which measures the value of one currency against a basket of others, has increased 14% since the beginning of the year. It has risen further on anticipation that the Federal Reserve will not back down from rising US interest rates to combat inflation, as emphasised by its chief, Jay Powell, at the annual Jackson Hole symposium last week.

The US currency's edge over others underscores concerns that rising European energy prices, fueled by Russia's war in Ukraine, could drive inflation higher and push nations into recession.

“Everything is pointing towards a stronger dollar,” said Christian Kopf, head of fixed income at Union Investment. “The dollar is independent from energy imports and not that much struck by the rise in energy prices that we’ve seen particularly in Europe,” he added.

The dollar will increase for the third month in a row in August, while pound and the euro have fallen 7.4% and 6.6%, respectively, over the same period. Japan's yen and Switzerland's franc are down 7.1% and 1.5%, respectively, over the same three-month period.

The Fed has led major central banks in tightening monetary policy aggressively. Higher yields on US government bonds drive up the dollar as investors sell debt denominated in other currencies in favour of higher yields on US Treasuries.

The yield on the two-year Treasury note, which moves in tandem with interest rate forecasts, reached 3.497 percent on Tuesday, its highest level since 2007.

Higher yields, as well as the accompanying strong dollar, have harmed emerging market economies. This is due in part to the flow of capital away from their assets and towards dollars, but it is also due to the fact that many emerging market countries have debt denominated in dollars. Because a stronger dollar means greater debt payments for those countries, some investors fear a wave of defaults.

Energy costs in Europe have reached all-time highs as the area seeks natural gas supplies that would otherwise come from Russia. As firms and people struggle, the EU is ready to announce emergency measures to address the region's spiralling energy costs.

“It doesn’t appear that they can really put up a decent fight against king dollar when we’re looking at this really sour backdrop,” Jane Foley, head of FX strategy at Rabobank, said about other major currencies. “If you’re going to sell the dollar, what are you going to buy?”

The stress is unlikely to go away anytime soon. In July, US inflation was 8.5 percent year on year, down somewhat from the previous month, but the Fed remains committed to its 2% inflation target. The EU's August inflation data were set to be released on Wednesday.

Last week, Fed Chair Powell reaffirmed his "unconditional" commitment to confronting high inflation, delivering a hawkish message at Jackson Hole and dispelling any concerns that the world's most powerful central bank would soon stop monetary tightening.

By fLEXI tEAM