This week, the dollar reached its highest level in 20 years, something that impacts other currencies, financial and stock market assets, and even the economies of the countries. And it is that, although there are 180 currencies worldwide, the US currency is the world benchmark for operations between countries and companies.
The dollar is the reference currency as about 60% of central bank foreign exchange reserves are in dollar-denominated assets, according to the International Monetary Fund. In addition to that, raw materials, such as gold, copper, oil and corn, among others, are denominated in dollars, their strength makes these products more expensive for those who have other currencies.
Why does the dollar go up and down?
Just like any other commodity, the value of coins is established through supply and demand; that is, how much they are buying and how many are in circulation. And its price is determined through other currencies, the so-called exchange rate, which is the price of a monetary unit of a country expressed in terms of a different currency. For example: 1 dollar is equal to 20 pesos, or what is the same, 1 peso is equal to 5 cents of a dollar.
To follow the performance of the US currency, there is the dollar index, which measures this currency against six others: euro, yen, pound sterling, Canadian dollar, Swedish krona and Swiss franc. This week, this index reached 109 points, its highest level since June 2002.
Some currencies have suffered the performance of the US currency, such as the euro, which for the first time in 20 years came to be worth less than the dollar. Although it also responds to fears that the euro zone will fall into an economic recession, which has reduced the demand for euros and financial assets denominated in that currency, causing their price to drop.
Why has the dollar gone up?
The strength of the dollar is not something recent. In fact so far this year, the currency has appreciated 14%.
The uncertainty and volatility that exists in the market is the main factor that has led the dollar to strengthen. After the ravages that COVID left in the economy, the world’s central banks lowered their rates, with this money becomes cheaper and people consume more and companies invest more. However, with increased demand for goods and services there is also an increase in prices.
Inflation is at a multi-decade high (in July it was 8.5% in the US and 8.16% in Mexico) and to control it, the central banks are raising their rates, reducing consumption and investment, as well as the economic rhythm.
In this scenario, investors usually demand more dollars for two reasons: the first is to protect themselves, since the dollar is considered a refuge asset; the second is to obtain more yields, with the rise in rates, Treasury bonds (which are denominated in dollars) become more attractive, because they pay more, in addition to being low risk. An increase in the demand for dollars leads to a strengthening of the currency.
When does the dollar drop in price?
When investors and the market in general stop demanding (buying) dollars and go to other currencies, the dollar weakens. This usually happens when the market is calm and confident, so the safety of the US currency is not sought.
Another factor that influences the decline in the dollar is that the instruments of other countries offer more attractive yields. For example, during the hottest months of the pandemic, with rates close to zero, few saw interest in buying Treasury bonds and were enchanted by emerging market bonds, which had higher rates, increasing demand for their currencies and appreciating them. against the dollar.
For now, analysts expect market volatility to continue for the rest of the year, so the US currency may remain strong.
