"Possibility of Strong Dollar Shift Due to US Economic Recovery and Inflation Pressure... Caution on Ripple Effects"

Risk-Averse Investment Sentiment May Emerge with Strong Dollar Shift
Watch for Exchange Rate Volatility and Financial Instability Mainly in Emerging Markets

[Image source=Reuters Yonhap News]

[Asia Economy Reporter Kim Eunbyeol] As the U.S. economic recovery accelerates, the growth gap with other countries is widening, and inflationary pressures are increasing, raising the possibility that expectations for a stronger dollar will gradually spread.

On the 16th, the International Finance Center stated in its report titled "Review of the Resumption of U.S. Dollar Strength and Risk Factors" that "there is a view that the second quarter of this year will be the short-term peak of the U.S. economy, and that the dollar will continue to weaken," but also noted, "Ultimately, strong dollar pressure stemming from U.S. inflationary pressures and growth gaps with other regions is expected to intensify."

While some interpret that if the U.S. economy slows after peaking, the Federal Reserve (Fed) will find it difficult to normalize monetary policy early, leading to a weaker dollar, others analyze that the dollar will strengthen due to the faster economic recovery compared to other regions.

The International Finance Center said, "The U.S. is expected to be almost the only major country to follow a growth trajectory better than pre-COVID-19 levels," adding, "The GDP gap is also expected to turn positive this year." In particular, it noted the possibility that inflationary pressures could be greater than expected, and that the Eurozone (19 countries using the euro) has structural weaknesses that make rapid economic recovery difficult, which would result in the dollar showing relative strength.

It also advised caution regarding the potential for financial instability centered on emerging markets if the U.S. strong dollar trend resumes. Although evaluations of emerging markets have improved compared to the past, the limitations of non-reserve currency countries remain.

Lee Sangwon, Deputy Senior Researcher at the International Finance Center, said, "The upcoming dollar strength is likely to be a negative form caused by sluggish growth and debt concerns in other regions, which could lead to a shift in international financial market sentiment toward risk-off," adding, "There is also a possibility that exchange rate volatility will increase during the friction process as market consensus gradually shifts toward a stronger dollar."

Due to structural changes in emerging market capital flows over recent years (reduced inflows/outflows of securities funds), concerns about foreign currency liquidity shortages may increase more than expected when the U.S. pursues monetary policy normalization, and the recent global increase in U.S. dollar borrowing could act as a boomerang in the future.

Total U.S. dollar debt in emerging markets increased by 4.8%, from $3.81 trillion at the end of 2019 to $3.99 trillion at the end of last year. The increase was particularly notable in Africa and the Middle East, with the Asia-Pacific region holding the largest balance at $1.48 trillion.

This content was produced with the assistance of AI translation services.