US Dollar is now trending at very high levels (DXY= 107.98). Last time it crossed these levels was in year 2000. US Dollar moves in tandem with interest rates in US. As interest rates rise, Dollar gains. Inflation has been rising and in response, interest rates are notched higher. Historically, US Fed had been quite aggressive in their interest rate actions (as per below table) during previous inflationary periods.
In continuation to my previous notes Fed's Word of hope and Bond Alarm, I emphasized that central banks have limited appetite to increase the interest rates, as US Fed is doing the tough talk on hike of interest rates rather than the act. The current interest rates hikes are not in commensurate with the levels of inflation, as they have been in the past. So what has changed now ? The Debt levels.
The US debt levels have surmounted at very fast pace over the last 2 decades, from 30% in 1974, 56% in 2000 to massive 124% now. Every 1 % rise in interest rates will increase the debt service burden by 1.24% of GDP. Thus, my view remains that interest rates hikes will be not as aggressive. Just two days back, Fed's talk suggested a dovish tone. (Dovish = Decrease in rates, Hawkish = Increase in rates). When debt levels are very high, they are managed through currency devaluation when the majority of debt is in its own currency.
Below table depicts levels of US Inflation, what were the interest rates in response and US Debt, and corresponding US Dollar Index value.
Below chart portrays the performance of US Inflation, US Interest rates, US Dollar and US Debt.
- Ushma
Source: Fed database, tradingview.com
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