The US dollar, the world’s reserve currency, has been in strong demand as of late. Not only has it crushed its emerging markets peers, but it soared against G10 currencies too. As the COVID-19 crisis continues, many wonder if this trend will change anytime soon?
Before the current pandemic, the Fed began adjusting the federal funds rate. Following a tightening campaign that lasted over two years. The few cuts delivered were viewed as “mid-cycle adjustment” – something to temper the booming jobs market and strong growth.
All this time, the other major central banks in the world held their rates close to zero – or below. The ECB, for instance, has had its key interest rate below zero for several years now. Even the RBA in Australia holds a lower cash rate than the Fed’s fund rate. All in all – the world’s reserve currency had the highest interest rate in the developed world before the coronavirus pandemic.
Enters the Pandemic
As the pandemic worsened, the Fed reacted quickly. It slashed the rate to zero in an emergency meeting and delivered a series of other unconventional measures to ease monetary policy further.
In a massive move, it opened swap lines in US dollars to provide liquidity in other parts of the world. During the 2008 financial crisis, a similar move benefited the Eurozone the most. Now, Asia in particular, seems to be drawing much of the dollar liquidity from the swap lines. Yet, despite the Fed’s massive reaction, the dollar has continued to strengthen.
One explanation is that in times of crisis, investors turn to the US dollar for safety. After all, if the US dollar does not hold, all other fiat currencies will likely follow.
Another, more plausible view, comes from the argument that it takes time for new measures to be implemented. Moreover, it takes even more time for their effects to be seen in the economy. As such, it comes as no surprise that the US dollar is still strong.
Only when the effect of the unconventional measures comes into play, the US dollar will begin to weaken.