Here’s a conundrum for adults: Countries stop using it, analysts predict its decline and regression, but it continues to grow stronger. What it is about? If you answered US dollars, you are absolutely right.
Despite the intentions expressed by BRICS leaders to increase the use of national currencies for trade and investment purposes, the dollar continues to gain dominance.
The latest transaction data compiled by financial messaging service Swift shows the role of the dollar in international payments has never been more critical. For example, in July, the percentage of transactions involving the dollar reached a record high of 46%.
And the resilience of the American currency can be explained by multiple reasons, including the strength of the economy and the hawkish stance of the Federal Reserve. The lack of geopolitical certainty on a global scale also plays its role.
Which would you prefer: a Eurozone currency that is one step away from recession or perhaps a China that is on the verge of falling into crisis?
To be honest, there is currently no viable alternative to the US dollar. Even though the Chinese currency is slowly integrating into the global monetary flow, its share remains relatively small.
In July, just over 3% of instructions sent via Swift were for the yuan.
The limited share of the world’s second-largest economy’s currency can be attributed to its lack of free convertibility.
For those who don’t know, there are restrictions on foreign exchange transactions in China, including foreign exchange and foreign exchange withdrawals.
Furthermore, the regulator occasionally intervenes in the foreign exchange market. If the Chinese Communist Party decides to devalue its currency, it can do so. In the past, Beijing has periodically used this practice to support its economy.
However, the current situation is quite the opposite.
As the yuan falls against the dollar to its lowest level since 2007, amid China’s economic woes, the PBOC will have to sell its reserves to strengthen its currency.
This is also where the greatest risk for the dollar lies today. If the Chinese regulator starts selling US Treasuries on a large scale, it could cause chaos in the markets.
As the supply of bonds increases, the debt market in the world’s largest economy will come under pressure, which could then flow through to stocks, leading to high volatility.
It is therefore not surprising that money market fund assets have reached a new all-time high. Approximately $14.37 billion was invested in U.S. money market funds in the week to August 30.
What does the dollar hold?
The fact that hedge funds are actively reducing their short dollar positions indicates that it is risky to bet against the US currency. The fact is that to combat inflation there are two options: raise interest rates again, which could lead to bankruptcies and a financial crisis, or cool the economy with a strong dollar.
The problem lies in the unexpected change of analysts, who collectively began to predict further strengthening of the US dollar until the end of this year.
Generally, it is prudent to err on the side of caution when there is consensus, meaning that if there is a dovish stance next week, the DXY Index could fall below the 104 mark.