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Dollar Relief in 2023

In 2022, a confluence of shocks reduced economic growth and simultaneously boosted inflation, causing investors to flee to dollar-denominated assets. Now, as fears about inflation and monetary policy begin to abate, the dollar should start to depreciate, adding a bright spot to the global growth outlook.

LONDON – Investors typically view the US dollar’s exchange rate through a Federal Reserve-centric lens. Yet while the Fed’s aggressive rate-hiking cycle clearly worked in the dollar’s favor last year, the greenback owed its hyperbolic 25% appreciation primarily to inflation and geopolitical shocks. Hence, as fears of inflation and uncontained military conflict have abated, the dollar has begun to weaken, offering much-needed financial relief to emerging-market economies and reducing pressure on other central banks to tighten policy.

Through most of 2022, investors ran for cover amid a rare confluence of shocks that reduced economic growth and simultaneously boosted inflation. With monetary policy much more volatile than normal, as well as highly correlated across developed economies (reflected in sharp interest-rate hikes almost everywhere), volatility rose in fixed income, foreign exchange, and equity markets, and the dollar – as the world’s primary reserve currency – prevailed as a safe haven.

Moreover, while the Fed played the leading role in setting the timing and magnitude of rate hikes, a series of independent shocks hurt growth in Asia and Europe. Thanks to its own energy independence and geographic distance from these shocks, the US economy was better insulated than most.