A Dollar Reprieve

The dollar has reversed its seemingly inexorable rise, with the weighted average dollar index falling from its 10-year high at the end of September. While it is too early to detect a trend, this development, alongside a softening of interest rates, is a welcome reprieve for emerging markets and low-income countries.

The dollar decline has been part of a series of economic and financial developments in the past few weeks.  Inflation softened slightly in October, with the Core CPI price index rising by 6.3% from a year ago, compared to 6.5% in September.  Crude oil prices fell to under $80 for the first time since the Russian invasion of Ukraine, down 32% from their peak of $118 on June 9, and 10% lower than the 11/8 level.  Interest rates are also lower, with the 10-year Treasuries yield falling below 4%.

A number of factors contributed to the softening dollar:

• An easing of political risks:    
• The U.S. mid-term elections proceeded smoothly.  Moreover, the unexpectedly strong performance of the Democrats, who kept the Senate and lost the House by  smaller-than expected margin, has strengthened the hand of the Biden Administration and offered a degree of continuity in U.S policies
• US-China tensions diminished after the Biden-Xi summit at the G20 meeting in Bali
• While the Federal Reserve remains committed to monetary tightening, the pace of the benchmark interest rate increases is expected to slowdown from 75 to 50 basis points by the next meeting in December 15-16 and thereafter, probably ending by March 2023. 
• The latest EU economic data indicates an improved outlook for early 2023.

These conditions are expected to prevail in the near term and should lead to an ebbing of the “flight-to-safety” of US assets. However, we should keep the short and medium-term risks in mind. First,  oil prices could surge again, as OPEC+ has yet to tighten supplies. Second, the risks to a global recession remain elevated. Third, global inflation has yet to be brought under control.   Nevertheless, these trends benefit the EM/LICs in a number of ways.  Lower oil prices and interest rate, as well as a weaker dollar reduce the macroeconomic pressure on inflation, the external accounts and debt servicing needs. At the same time, the LICs have received climate-related financial commitments from the more advanced countries/major polluters, which should consolidate their financial position in the medium and longer-term. The favorable trends discussed above might be fleeting and we need more data on inflation and economic performance to get a better handle on the global economic outlook. However,this short-term reprieve should be used by policy-makers to make progress on the global financial architecture.