20 February 2019
The decline in commodity prices as the US dollar strengthens has put deflationary pressures on Japan and many other economies. Photo: Bloomberg
The decline in commodity prices as the US dollar strengthens has put deflationary pressures on Japan and many other economies. Photo: Bloomberg

Why strong US dollar will shake global markets in 2015

The US dollar will continue strengthening in the first half of this year unless the US Federal Reserve launches a new round of quantitative easing.

Global financial markets face a severe crisis unless the Fed reverses its strong-dollar monetary policy.

Commodity markets will bear the brunt of the strong greenback, and falling commodity prices will spark a chain reaction.

Since the beginning of the year, commodity prices have constantly tested new lows, which has given rise to deflation pressures worldwide, in particular on struggling economies like Europe, Japan and many emerging markets.

A super-strong dollar will cause global economic growth to decline or even trigger a global recession.

As many emerging nations rely heavily on exports of commodities or raw materials, falling commodity prices have inflicted a shock to their economies.

It’s possible that could lead to a financial crisis in emerging markets this year, on a scale similar to the 1997 Asian financial crisis or the 1994 Mexican financial crisis.

The US dollar has been on the rise since the second half of last year. The Asia Currency Index, which tracks Asia’s most-traded currencies except the Japanese yen, and the JP Morgan EMCI index, which is a gauge of emerging market currencies, have kept sliding.

Capital has been flowing out of emerging markets, and the MSCI Emerging Markets Index of equities has fallen 15 percent from its peak.

This may be a prelude to a bigger crisis.

Many financial institutions, the bulk of them from emerging markets, have been enticed to issue massive amounts of US dollar bonds or notes in the past three years to take advantage of historically low interest rates. 

These firms will face growing difficulty in repaying their US dollar debt as the currency strengthens, since their earnings are mainly in other currencies.

The United States itself may not be totally isolated from the effects of its strong dollar, which may hurt its exports, push up inflation and dampen consumption.

And big corporations that generate a substantial part of their revenue from non-US markets may also be negatively affected.

Historically, strength in the US dollar is negatively correlated with the earnings of the constituents of the S&P 500. 

Nevertheless, the US dollar is in the middle of a long-term upward cycle.

That will put unprecedented deflation pressure on global economies and exacerbate the risk of a global recession.

In addition, the strong greenback will accelerate capital outflows from emerging markets, which will also hurt the US eventually.

In these circumstances, central banks in Europe and Japan may be forced to step up monetary easing in an attempt to offset negative economic effects from a stronger US dollar.

Global financial woes could encourage risk-off sentiment, prompting investors to flock to the US dollar as a safe haven.

That would further drive up the US dollar in a feedback loop that could lead to a financial crisis.

This article appeared in the Hong Kong Economic Journal on Jan. 8.

Translation by Julie Zhu

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Hong Kong Economic Journal chief economist and strategist

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