Last Updated: 02/02/2023

How strong is the US dollar? Volatility amid 2023 recession fears

The greenback has managed to hold on for much longer than initially expected. Although it has maintained its decade-long bull run, entering 2023 with a 43 percent surge in value since 2011, financial analysts are anticipating the start of a bearish period after the shadow of a recession became evident in the previous year. 

With historically high inflation rates worldwide and the slowdown of several major currencies, economists agree that the world will soon enter a recession. Last year witnessed great challenges both financially and politically. Not only did the world see a loss of major gas and grain exports in the Russo-Ukraine conflict, but China’s reopening also further raised inflation concerns as the formerly-locked economic giant bought up more commodities, driving prices upward.

Interestingly, the U.S. Federal Reserve has also played a hand in the recession, slowing down the economy after aggressively raising interest rates throughout 2022. The move put massive pressure on the U.S. economy, introducing a significant decrease in home sales and a rise in consumer inflation. 

However, against all odds, the U.S. dollar has managed to maintain its standing. Economists suspect the Fed’s recent rate hikes have managed to banish fears of runaway inflation. The nominal broad dollar index is now appreciated at over 12 percent, soaring over other currencies in 2022.

A weakening strength

The U.S. dollar’s bull run had investors and now-slowed federal rate hikes to thank for its ongoing success. Investors favored the dollar as a safe bet in times of uncertainty and turned to it during the tumultuous 2022.

Embargoes against Russia for its invasion of Ukraine led to rising gas prices and a subsequent energy crisis in Europe, which made the region risky for investors. China was also still closed due to its zero-COVID policy at the time, and its restrictions led to a major downturn in the Asian giant’s economy.

However, financial analysts projected that the dollar’s strength would trigger its downfall. The dollar’s strength, relative to its counterparts, would have led U.S. exported products to become less competitive in the global market, owing to the higher price than foreign markets. This would later lead to U.S. financial assets losing value to foreign investors.

It doesn’t help that now, in 2023, other major currencies are set to grow further, possibly outperforming the dollar in the future, setting up a possible reversal for the dollar as its power wanes coming into the year.

Downward trends

Though the U.S. dollar has staved off initial worries, long-term outlooks point to a downward trend for the dollar. The dollar’s index (DXY) is only a few pips away from reaching a monthly new low, a fall that began after last November.

While this has been developing for several months, it came as a surprise to some analysts. The dollar’s initial strength led to some optimism in the financial sector, which was tampered with by the Fed’s decision to tighten its monetary policy. This optimism came largely from the dollar peaking above every other major currency around September to November.

Some analysts claim that the U.S. dollar has been overvalued in the past months. Viewing the dollar’s real effective exchange rate, or how the currency measures against an average of other foreign currencies, the dollar is said to value only one standard deviation higher than the average.

The dollar’s purchasing power has also been questioned, as it fails to match up against other G10 currencies. It has even been overvalued by 30 percent against the Japanese yen.

The worsening situation in the U.S. is making the country lose its status as a safe haven amongst investors. Europe has largely overcome its energy crisis after initial fears of the consequences of Russia’s invasion, leading to investors slowly flocking back to its shores. China also opened its borders in December, entering the global economy once more after more than two years of being closed off. China’s return may also support growth, further challenging the U.S. dollar’s safe haven status.

While the Fed is likely to increase interest rates to combat these trends, it may already be too late. After federal debt rose to $31.35 trillion this year and inflation rose to its highest in 40 years, the U.S. dollar is set to weaken further into 2023.

US Dollar illustration. (Unsplash/Jinyun)

History repeats itself

Interestingly, the U.S. dollar’s current fall has a similar pattern to that of 2008. After an unexpected implosion in the tech industry in the 2000s, investors flocked to the dollar once again, identifying it as a safe haven. The market rose at an alarming rate, rising to 15 percent in 2002.

However, once the Fed lowered rates on stocks, investors fled, and the value of the dollar’s stock went down once again. The stocks then continued to see a rapid 40 percent fall, losing nearly all of the value they had gained.

This event mirrors that of the dollar’s current situation in 2023. While it was considered a safe bet in the turbulent storms of the world’s crises, many of its former issues have returned to bite back in the worst moment possible. While history may not be guaranteed to repeat, the current course heavily suggests that the U.S. dollar may see volatile times ahead.

What will this mean for investors?

Investors use the U.S. dollar as a safe haven compared to the uncertain outlook in Europe and the then-closed economy of China. However, they may lose their bets in the dollar’s coming downfall.

While the dollar’s index rose and fell, the S&P 500, arguably the best measurement of the U.S.’s performance in the stock market, showed a concerning decline. International markets gained traction against the falling value of the dollar, which significantly decreased the price of commodities.

Investments in the S&P over this tumultuous period will likely lead to little yield this year. Furthermore, some countries will see a loss in investment in the U.S. stock market, with Canadian investors losing a large amount of their investment value in the currency exchange.

Further worsening the situation is the rising inflation. After years of stimuli and reckless spending, thanks to geopolitical uncertainty and a global pandemic, the U.S. dollar value may see an end to its bull run, along with investors’ trust.

Some analysts have recommended that investors consider investing in currencies other than the dollar. Notable winners for 2023 may be euros, yen, pound and the Swiss franc, all of which have shown notable strength coming into the new year.

However, while other currencies are catching up to the dollar, the value gap is still substantial in its current state. In the long term, diversifying investments and bonds may be the best option for investors. Hedging away from the U.S. dollar is currently considered a wise decision. Analysts predict that the dollar will stabilize in the middle of the year, returning to its pre-pandemic average.