Will 2022 be the year of the dollar?

Will inflation spiral out of control in the coming months? Or will an unexpected event make 2022 an exciting year? In either case, the dollar could have a tailwind.

Slowly but surely you can buy less and less for your euros. Next Tuesday, CBS will announce how much purchasing power has fallen in December. In November, inflation of 5,2% had already reached its highest level in nearly 7 years. That is child's play with what is happening in the United States. Inflation there has risen to almost 2%. In some cases, the price difference is even greater. For example, Americans spend more than half more than twelve months ago at the gas pump. Even if the rise in the oil price does not continue, it can already be seen that inflation will for the time being well exceed the 2022% that the American bank is aiming for. That will provoke a reaction in XNUMX.

The main weapon against inflation
Raising interest rates is the Federal Reserve's main weapon in keeping inflation under control. In line with rising inflation, the likelihood of a series of interest rate hikes in the United States has increased sharply. In mid-September, traders on the CME futures exchange were pricing in a 50% chance that interest rates would not rise in 2022. Currently, that chance is only 1%. Traders are anticipating three (30% chance), four (24% chance) or even five (11% chance) rate hikes in the current year. The rising interest rate expectation is echoing hard on the foreign exchange market.

Flame in the pan
High interest rates make it more attractive for parties to hold capital in the corresponding currency. Since interest rate expectations in the United States started rising around mid-September, the dollar has appreciated by 4% against the euro. If US inflation remains high and the likelihood of a series of rate hikes increases further, the dollar may gain more ground. But the currency also has good prospects if the fire unexpectedly flares up. The dollar is considered a safe haven in the currency world. As the coronavirus panic peaked in March 2020, the dollar climbed to its highest level in nearly three years against the euro.

Shock effect
From a geopolitical point of view, an escalation of the conflict between China and Taiwan or a Russian invasion of Ukraine could create a shock effect. In addition, the arrival of a new, dangerous corona variant or another unexpected development could mean that 2022 will be an exciting year. Incidentally, the dollar will only benefit from its role as a safe haven if the panic really hits the financial markets. If a setback only causes economic growth to slow down, it will mean that US interest rates rise less than traders are now pricing in. That has a negative effect on the dollar. Although the currency has good prospects at the start of 2022, it will be very interesting to see where the dollar stands when the balance sheet of the year is drawn up in twelve months.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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