The greenback has already been in a slump for more than seven months, weighed down by signs of a weakening U.S. economy plus the prospect of the Federal Reserve pausing its interest rate hikes soon and even cutting borrowing costs.
The ICE U.S. Dollar Index DXY is down almost 11 percent since late September last year. Now, Treasury Secretary Janet Yellen is warning that a default on U.S. debt would have an “adverse impact” on the dollar’s role as a reserve currency, a scenario that’s been much speculated upon and many have pushed back against.
So far, anxiety over the debt ceiling has been largely contained to the short-term Treasury bill market, but that could change. Volatility in currencies could grow with inflation data due and as the U.S. debt-ceiling debate continues “to fuel anxiety among traders,” said Daniel Takieddine, the Dubai-based head of the Middle East/North Africa region for global financial services company BDSwiss.
Meanwhile, Yellen is calling chief executives personally to explain the “catastrophic” impact a U.S. default on its debt would have on the U.S. and global economies, Reuters said, citing two sources familiar with the matter. If the U.S. does default on its debt, the immediate reaction in financial markets would be “dollar-negative,” Nakamura of AGF Investments said via phone. Other currencies — whether it’s the euro or the Swiss franc — or even commodities such as gold “are likely to benefit pretty significantly.”
Though the U.S. dollar rose against the euro and pound earlier on Tuesday, gains for the U.S. currency could be limited over the long term, given the direction of monetary policy in other countries, according to Takieddine at BDSwiss. “Both the European Central Bank and the Bank of England are expected to continue raising rates during the next few months while the Federal Reserve could pause and potentially reduce rates,” the BDSwiss executive wrote in a note on Tuesday.