Inflation Now Affects Every Country in the World

Inflation dominates headlines as the world tries to adjust to a new normal after decades of stable prices. It has impacted the FX world and will play a significant role in determining winners and losers in the vast world of currency trading.

Significant Current Effects on FX

The dollar has been the primary beneficiary of an inflationary world. This is mainly because the U.S. is better situated to weather the adverse effects of higher energy and food prices than most other countries. The dollar’s current strength has been aided by an aggressive Fed raising interest rates faster than at any time in recent history.

Conversely, the Japanese yen is the biggest loser among major currencies. Japan suffered from a sluggish economy even before the current inflation became evident. The Japanese central bank (BOJ) has resisted the global trend to raise interest rates, and the rate differential has caused flows out of the yen in search of higher yields.

Some experts predict that inflation will be contained soon, returning the world to stable prices, and central bankers are praying that those predictions are correct. However, most economists view this as wishful thinking. Higher interest rates will dampen demand but will not affect supply chain issues. Make no mistake—today’s inflation is supply-driven.

How Inflation Will Affect the Future of FX

Commodities will likely continue to increase in price. That means that “commodity currencies” will appreciate over time. The main commodity currencies are the Canadian dollar and the Australian dollar. The United States is self-sufficient in food and energy, so the dollar should also benefit from higher commodity prices.

Countries reliant on imported energy and food will experience weakening currencies as raw materials rise in price. Large trade deficits will likely put downward pressure on the currencies of resource-poor countries. Chief among these currencies is the Japanese yen, but the Eurozone is also a big importer of commodities, so expect ongoing pressure on the euro.

Emerging markets will face challenges as most of these countries depend on imports for their needs. Many also have dollar-denominated debt that becomes more expensive to service when interest rates rise and the dollar appreciates. Expect to see debt crises develop in many parts of the world and for currency devaluation to become commonplace.

Preparing for the Future

Here’s the good news. FX moves tend to be incremental in nature and persistent over time. That means you have time to prepare for expected currency movement.

The dollar is still the reserve currency of the world, and the U.S.’ energy independence and relative self-sufficiency in most basic commodities will likely keep the greenback strong for the foreseeable future. The dollar also benefits from having higher interest rates than most other currencies.

Investors may hesitate to put money to work in emerging economies because of FX risk, so tools for hedging that risk will be essential to facilitate investment in less-developed countries.