Strong U.S. dollar could weigh on the global economy. Here's why that hasn't happened yet, according to Capital Economics.

By Isabel Wang

A string of global currency crises looks unlikely despite the surging dollar, says Neil Shearing at Capital Economics

The surging U.S. dollar is once again sending shivers through global financial markets, risking fracturing international trade and stoking currency fears for economies large and small. But the consequences of a strong dollar could be exaggerated, according to Capital Economics.

The U.S. dollar has had a strong start to 2024, with the ICE U.S. Dollar Index DXY, which measures the currency's strength against a basket of six rivals, up for four consecutive months. The index has advanced 1.1% so far in April, on pace for its best month since January and on track for its longest monthly winning streak since September 2022, according to Dow Jones Market Data.

The surging greenback reflects the relative strength of the U.S. economy as domestic demand remains robust and inflation is still running hotter than expected, which is giving the Federal Reserve confidence to keep interest rates higher for longer and push out market expectations for the timing of the first rate cut.

Also read: Stocks risk a wild week with Big Tech earnings, Fed's faceoff with inflation

While a strong dollar is largely good for U.S. consumers, because it holds down inflation by keeping import prices in check and makes traveling to other countries cheaper, it could cause a few headaches abroad.

A strong dollar could fuel inflation risks in countries outside the United States, pushing up the local-currency cost of imports and acting as a headwind to global trade and activity more generally, said Neil Shearing, group chief economist at Capital Economics.

The dollar's strength also makes dollar-denominated debts overseas more costly. Rapid moves in exchange rates generate uncertainty about the future value of foreign-currency-denominated assets and liabilities, which could create "significant financial dislocation that threatens broader macro stability," Shearing said in a Monday note.

However, the move in the dollar so far in 2024 has not been large or fast enough to cause a string of currency crises for other countries, Shearing said, adding that the U.S. dollar index, which was trading at 105.60 as of Monday afternoon, has risen only 4.1% so far this year, which means it has moved "steadily rather than abruptly higher."

Meanwhile, Shearing said that the inflationary consequences of a strong dollar and weak domestic currency for other countries depend on "several factors" that include the import intensity of the economy, the composition of imports and the size of the currency move.

"There is no simple rule of thumb," Shearing wrote. In fact, he said there is an inverse relationship between the strength of the dollar and global import-price inflation, because a strong dollar typically weighs on commodity prices (see chart below).

In addition, while a strong dollar might harm global trade and activity, such an outcome is often overwhelmed by other factors in practice, Shearing wrote.

The chart below shows the inverse relationship between moves in the dollar and changes in world GDP, excluding the U.S., and it is principally because weaker economic growth leads to a rise in risk aversion in markets, which pushes up the greenback. "In other words, the causation runs from the global economy to the dollar rather than the other way around," Shearing said.

U.S. stocks were edging higher on Monday afternoon, lifted by some megacap technology names such as Tesla Inc. (TSLA) and Apple Inc. (AAPL). The S&P 500 SPX and the Dow Jones Industrial Average DJIA were each rising 0.4%, while the Nasdaq Composite COMP was up 0.5%, according to FactSet data.

-Isabel Wang

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04-29-24 1453ET

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