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Near the end of an unstable year for the global economy, the US dollar reached a roughly 20-year high.
Several factors, local and international, contributed to the strength of the dollar. Although economic conditions may change in 2023, experts expect the dollar to hold a strong position.
Why is the US dollar so strong?
We asked experts to break down why the US dollar strengthened against other currencies in 2022. They offered some key explanations:
The US dollar is still considered a safe currency
The role of the dollar in the global economy was a major factor in its strength in 2022.
The currency’s reliability has made it the dominant global reserve currency since World War II, meaning it is used by most central banks around the world for international trade and financial transactions.
“The main reason why the dollar has strengthened is that it is still considered the safe haven currency, and it will strengthen in times when the markets are in a state of fear,” explains Eric Donovan, head of institutional foreign exchange at StoneX, a financial services company.
Dave Shabbs, assistant professor of instruction at the University of Chicago’s Harris School of Public Policy, adds that the war in Ukraine is a specific and contributing factor.
“The United States has always been seen as the world’s number one safe haven in times of political or military uncertainty,” he says. “When actual war broke out, investors looked for stable places to put their money until the war resolved itself.”
Meanwhile, Russia’s war in Ukraine threatens to slow economic growth across Europe and drag the continent’s energy crisis into 2023 and possibly 2024.
Continue raising interest rates
The strength of the dollar, measured in the US dollar index (USDX), is relative to the other currencies. This means that the economic policies of other countries play a role in its value.
In particular, the dollar index measures the dollar against the euro (EUR), Japanese yen (JPY), British pound (GBP), Canadian dollar (CAD), Swedish krona (SEK) and Swiss franc (CHF).
Unlike the US dollar, these other currencies have not been subject to the same interest rate hike policies that have been in place to slow US inflation. “While all of these countries have raised interest rates,” Chabbs says, the US has raised them far higher.
“The US can afford to do this because the US economy is still quite strong,” he explains, “while the Eurozone suffers from weakness in a number of countries, exacerbated by the increase in prices both directly in natural gas and oil and knock-on effects through the supply chain.”
According to Michael Medovitz, director of macroeconomic policy at the Washington Center for Equitable Growth, the slowdown in inflation in the US has also led to the diversion of investors’ money away from other countries and into the US.
Will the US dollar grow in 2023?
Several changing factors may affect the value of the dollar in the coming year.
It is uncertain whether the Federal Reserve will continue to adjust interest rates, but the United Nations has encouraged the agency to halt the hikes. Further hikes, it said, could spur a global recession and hurt developing countries already hit hard by the increased cost of American goods.
Still, there may be further interest rate hikes. “Until the Fed sees that inflation is substantially moderating, and as long as the US economy does not fall into recession, I expect the Fed to continue raising interest rates until much of 2023,” says Shabbs.
At the same time, other countries have started to introduce their own rate hikes and may continue, which could balance the dollar situation.
“With interest rate hikes on the planet,” says Madovitz, “the higher interest rate in the US is part of the strong dollar story, but much less than we would expect given how quickly the Fed raised interest rates.”
The ongoing conflict in Ukraine is also expected to play a role in the dollar’s value in 2023. Both Donovan and Chaves expect the dollar to remain strong against European currencies as long as the war continues.
How does a strong dollar benefit US consumers?
A strong dollar has mixed implications for US consumers.
As the currency appreciates, U.S. stock prices can be expected to fall, which means a loss in the value of retirement savings for many investors. One study by Northwestern Mutual found that the average retirement savings balance has fallen 11% since 2021.
On the plus side, higher dollar values mean some products are more affordable. “A strong dollar makes imported products more expensive compared to locally produced products,” Shabbes says.
According to data from the Bureau of Labor Statistics, the price of imported goods fell by 1.1% in September – when the US dollar reached its peak – and by another 0.2% in October.
Travel abroad can be more budget-friendly when the dollar strengthens, especially in areas where it has grown against the local currency. As of the end of 2022, this includes Japan, the UK, Sweden, Switzerland and Canada.
