As of yet, 2023 has been a year like no other. Over the last year, many of the world’s central banks have raised interest rates to quell persistent, post-pandemic inflation. Meanwhile, two major conflicts persist—the ongoing war between Russia and Ukraine, as well as the more recent escalation between Israel and Hamas.
If a global feeling of uncertainty hangs over the months ahead, it’s no wonder why.
For central banks, such as the U.S. Federal Reserve and the European Central Bank, the prevailing question is whether they have done enough to bring inflation down without risking a spike in prices when they eventually change course (though that’s not to say any rate cuts are on tap for the near future).
Meanwhile, although many of the Russia-Ukraine war’s effects on international markets have been seen, there is still the question of whether the conflict will spread to other Eastern European nations. There are also more immediate concerns about whether the war between Israel and Hamas will spread and what the effects will be.
With these issues in mind, here’s what to watch for in the remainder of the fourth quarter:
Stronger U.S. dollar
After steadily raising rates, the world’s central banks are waiting to see how inflation will react to these higher rates. This wait-and-see approach makes sense, given that the effects of monetary policy typically lag when the policy was first put in place.
In the U.S., as anticipated, the Fed skipped raising rates at its November meeting, which was only the third time the Federal Open Market Committee has decided against higher rates since March 2022. However, analysts are divided on whether the Fed will hike rates again before the year ends.
The U.S. is in one of the fastest rate-hiking cycles the country has ever seen, which has been bad for borrowers but good for buyers of the U.S. dollar. A 10-year Treasury note now is expected to earn 5% over that period—a far cry from when rates were at 0%.
The wars in Eastern Europe and Middle East are also boosting the dollar because of the perception that it is a safe-haven currency. That’s also why gold—another famous safe haven—is outperforming.
People and companies conducting international business in U.S. dollars have more purchasing power now because of the dollar’s strength against other currencies. On the flipside, those with overseas investments in other currencies will see the value of those investments come down if they don’t hedge effectively.
End of rate hikes globally?
Outside the U.S., the European Central Bank and the Bank of Japan are probably done raising rates and are waiting to see if holding rates high will continue to lower inflation. The Bank of China, meanwhile, has been lowering rates incrementally as it tries to jumpstart its economy after years of lockdown during the pandemic. Mexico’s central bank may also lower rates.
Other than the U.S. Fed, the Bank of England is the only other major central bank that may hike rates one more time. The BoE has struggled to bring prices down, and the UK now has one of the highest inflation rates in the G7 (6.3% year-over-year), as of September. This is partly a lasting effect of Brexit, and the inflationary effects of the UK continuing to import much of its energy. However, there are talks of reopening North Sea oil drilling.
The Bank of Israel is also facing the need to act, as the shekel has dropped considerably since the war between Israel and Hamas began. Although the central bank has not changed rates in response, it has said that it will sell up to $30 billion in foreign exchange and make swap transactions of up to $15 billion in the foreign exchange market to try to stabilize the currency so that business can continue to be conducted.
Over the past 15 years, Israel has benefited from international technology companies opening offices there because of the nation’s young, educated workforce. These companies probably will not pull out from Israel entirely, but they may consider how to move forward. As long as the war continues, they are unlikely to make further investments in their operations, another factor bringing down the shekel.
The world will continue to watch the situation in the Middle East—as well as the war between Russia and Ukraine—with bated breath. We will closely monitor these and other global events impacting the currency market and keep you informed.
. © 2024 BOKF, NA.