The U.S. Dollar (USD) has been one of the few currencies that has strengthened against most major currencies in 2022. Relative to the Ringgit, the USD appreciated by 5.7% to RM4.40 per USD over the year.

The movements of the USD, also known as the greenback, are closely watched by global investors as their investments are often denominated in currencies that are influenced by the USD’s trend. For consumers and corporations, the USD plays a key role as it is the most widely-used currency to settle international transactions in goods and services. Furthermore, key commodities (e.g. crude oil and agricultural products) are priced in USD.

In this FAQ, we explain the U.S. Dollar’s recent trend, its key drivers and the implications for investors.

1. What is the USD’s trend in recent years?

Over the 10-year period of 2012-2021, the USD Index – which is a measure of the value of the USD relative to a basket of major currencies – has registered a gain of 1.8% per annum (Table 1). During this period, the American economy grew by an average of 2.1% per annum amid a low interest rate environment.

Following an appreciation of 6.4% in 2021, the USD Index continued to rise by 8.2% in 2022 (Table 1). Compared to individual currencies, the greenback’s annual appreciation was 14.5% against the Japanese Yen, 8.9% against the Chinese Renminbi and 6.1% against the Euro in 2022 (Figure 1).

Table 1: Performance of the U.S. Dollar

2. Why did the USD strengthen in 2022?

The USD appreciated against most major currencies in 2022 due to three key factors:

(a) Fast pace of U.S. interest rate increases
To contain inflationary pressures in the U.S., the Federal Reserve (Fed) raised the Federal Funds Rate (FFR) aggressively by 425 basis points (bps) to 4.50% in 2022. In comparison, while most other countries have also been raising their respective policy interest rates, their hikes were not as steep as the Fed’s. With the U.S. financial markets offering more-attractive yields on their Treasuries, corporate bonds and deposits relative to offshore securities, the increased demand by global investors for such U.S. assets has helped the USD to appreciate.

(b) Safe-haven demand
The USD is generally considered a safe-haven currency in times of heightened global economic and geopolitical uncertainties as global investors seek to limit their exposure to riskier currencies in favour of the USD. For example, following the invasion of Ukraine by Russia on 24 February 2022, the USD Index rose by as much as 18.6% to a 36-year high of 114.1 on 12 October 2022 before ending the year with a gain of 8.2% at 103.5 as at end-December 2022.

(c) Relative fundamentals of the U.S. economy
The USD’s relative strength in 2022 was also supported by expectations that the U.S. economy would be less affected by the surge in energy prices compared to other major economies which are importers of oil and natural gas such as the Eurozone and Japan. While the rise in gasoline prices in the U.S. has resulted in higher costs of living for American consumers, the U.S. is still a fairly energy-independent country.

3. Why has the USD retraced recently?

The USD Index retraced by 8.6% from mid-October to end-December 2022 on expectations that the Fed would slow its policy rate hikes following a moderation in the U.S. monthly inflation rate from the year’s high of 9.1% in June 2022 to 6.5% in December 2022.

4. What is the impact of a strong USD on the global economy?

(a) Higher cost of imports and inflation for other countries
As most of the world’s commodities are priced in USD, a stronger USD raises the cost of imported goods for other countries, resulting in higher domestic inflation. For example, higher food and utility costs have driven Malaysia’s inflation rate to a 16-month high of 4.7% in August 2022, compared to its 10-year historical average of 1.8%.

(b) Higher USD debt-servicing costs
A stronger USD also raises the cost of debt for borrowers with USD-denominated loans. As the USD-denominated loans have to be repaid in USD, an appreciating USD makes it more costly for these loans to be serviced. Thus, countries or companies with a high proportion of USD-denominated debt will be financially strained when their currencies depreciate againts the USD.

5. How does the USD’s movement impact your fund investments?

The performance of funds which are invested in the U.S. markets is affected by the movements of the USD against the Ringgit when the funds’ USD-denominated investments are translated to Ringgit terms.

In general, when the USD appreciates against the Ringgit, funds invested in USD–denominated assets will register higher returns in Ringgit terms, and vice versa.

For example, the S&P 500 Index registered a narrower loss of 14.7% in Ringgit terms compared to the index’s decline of 19.4% in its USD base currency for 2022 (Figure 4).

The Ringgit-based returns of key equity markets are reported in our Monthly Fund Review report and made available to investors through the Public Mutual Online (PMO) portal. The Ringgit-based market data is useful for local investors to assess their returns for investments in foreign markets after accounting for changes in their respective exchange rates.

Conclusion

To recap, USD movements can impact fund returns when investments in U.S. financial assets are translated to Ringgit terms. Over the short term, currency movements may be volatile due to a range of factors (e.g. U.S. interest rate changes and safe-haven demand).

Nonetheless, long-term investors who are invested in a diversified portfolio across the global, regional and domestic markets should be better-positioned to ride through the volatility of currency movements.