The weakening of the US dollar could force central banks to devalue currencies

The dollar has slipped and the training effect on other currencies has brought a mixture of relief and headache to central banks around the world.

Uncertainty about the development of American policies has led to a flight outside the US dollar and treasure in recent weeks, the dollar index weakening more than 9% this year. Market observers see other drops.

According to the latest Global Fund Manager survey of Bank of America, 61% of participants provide for a drop in the value of the dollar in the next 12 months – the most pessimistic prospects of the main investors in almost 20 years.

The exodus of American assets can reflect a wider crisis of confidence, with potential benefits such as imported inflation as the dollar is weakening.

The drop in the greenback has led other currencies to appreciate against, in particular security shelters such as the Japanese Yen, the Swiss franc as well as the euro.

Since the start of the year, the Japanese Yen has strengthened more than 10% against the greenback, while the Swiss franc and the euro have appreciated around 11%, according to LSEG data.

Aside from the shelters, the other currencies that have strengthened compared to the dollar this year include the Mexican peso, up 5.5% compared to the dollar and the Canadian dollar which appreciated more than 4%. The Polish zloty has strengthened more than 9% while Russian Ruble appreciated more than 22% against the greenback.

However, some emerging market currencies have brought up despite the weakness of the greenback.

The Vietnamese Dong and Indonesian rupee were weakened at a record level by US dollar earlier this month. The Turkish LIRA also reached a hollow of all time last week. The China Yuan reached a record record against the dollar almost two weeks ago, but has since strengthened.

Without a few exceptions such as the Swiss National Bank, a weakened US dollar is a relief for governments and central banks around the world, analysts at CNBC said.

“Most central banks would be happy to see drops from 10% to 20% of the US dollar,” said Adam Button, currency chief analyst at Forexlive. He added that the strength of the dollar has been a persistent problem for years and poses a difficulty for countries with hard and soft ankles.

With many emerging markets with a debt denominated by a large dollar, a lower dollar reduces the real debt burden. In addition, a softer green tank and a stronger local currency tend to make imports relatively cheaper, reduce inflation and thus allow central banks to reduce rates to increase growth.

The recent sale of the US dollar offers more “breathing margin” for central banks to reduce rates, said Button.

Although a stronger local currency can help to tame inflation via cheaper imports, it complicates the competitiveness of exports, in particular under renewed American prices, where Asia is exposed as the largest producer of goods in the world, said Thomas RUPF, co-chief of VP Bank for Singapore and director of investments in Asia.

The devaluation of currencies is likely to be more an active consideration on the emerging markets, in particular in Asia, declared Nick Rees, chief of the macro-research in my Exte Europe.

However, these emerging markets and Asian central banks will have to cross a fine line, to avoid capital leak and other risks.

“The emerging markets are faced with high inflation, debt and the risk of capital flight, making the devaluation dangerous,” Wael Makarem said, the strategists of the financial markets lead to Exness.

In addition, the devaluation could be considered by the American administration as a commercial measure which could attract reprisals, he added.

Emerging market savings can hesitate to reduce rates because they can affect the burden of national household and businesses that have borrowed in US dollars, said Fitch Ratings economy, Alex Muscatelli. A lower interior currency can also lead to capital outings in response to a drop in differentials of interest with the United States, he added.

For example, Muscatelli does not see the cup rates of the Central Bank of Indonesia too much, given the recent volatility of currencies, but has cited that Korea and India can have a space for reduction of rates.

The European Central Bank took advantage of the opportunity offered by the drop in inflation to reduce the rates of another basic point at its April meeting. On Thursday, the ECB said that “most of the underlying inflation measures suggest that inflation will settle around the medium-term objective of the governance council on a sustained basis”.

Another example is the Swiss National Bank, which has faced a strong franc for much of the last 15 years, button observed. Exports of goods and services represent more than 75% of Switzerland GDP and a strong franc makes Swiss goods more expensive abroad.

“If the capital continues to flow, they may have to take drastic measures to devalue,” he said. Investors flood in the franc during times of uncertainty, like in recent weeks, the strengthening of the franc.

The devaluation of the currency poses the risk of catching up prices and the monetary authorities will be wary of inflation above their objectives.

The risk of higher inflation resulting from the depreciation of currencies as well as prices – because countries react to American samples – are likely to make central banks reluctant to follow a voluntary devaluation path, said the international economist of Wells Fargo and the FX strategist, Brendan McKenna.

In addition to this, while most foreign central banks theoretically have the bandwidth to weaken their own currency, the probability is still low in the current environment, added the strategist.

The question of whether a country can devalue its currency is influenced by several factors: the size of its FX reserves, exposure to foreign debt, its trade balance and its sensitivity to imported inflation.

“Countries oriented towards export with sufficient and lowest dependence on foreign debt would have more room to devalue – but even they are likely to work with care,” said McKenna.

The broader management of commercial negotiations will be the key to how countries choose to act. Aside from China, several countries have shown a desire to engage in commercial negotiations, and if these talks lead to lower prices, central banks will not also be likely to pursue lower currencies, he added.

In the current geopolitical climate, devaluation could also invite reprisals and risks of accusations of manipulation of currencies, said RUPF of VP Bank.

Although there is always the possibility that trade tensions can lead to more protectionist results, which will encourage central banks to devalue their currencies.

“But for the moment, it seems that the favorite action avoids a monetary war which would only add more instability to the local and world economy,” said McKenna.