Dollar Holds Near Six-Month Highs Amid Inflation Concerns and Fed Hawkishness

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The dollar has stabilized near six-month highs, as ongoing signs of inflation in the United States continue to fuel concerns about the Federal Reserve’s hawkish stance. In the unofficial foreign exchange market, commonly known as the parallel market, the naira depreciated to N930 to 1 dollar on Thursday. This decline was amplified by Nigerian banks struggling to meet the escalating demand for dollars, prompting buyers to turn to the parallel market.

The Central Bank of Nigeria’s (CBN) plan to clear foreign exchange debt in the next two weeks is expected to restore confidence in the economy. Acting CBN Governor, Folashodun Adebisi Shonubi, stated on Monday that discussions on reducing the foreign exchange backlog have been ongoing, and they anticipate resolution within the next two weeks.

The dollar is currently at its highest since mid-March, with the dollar index showing minimal movement in London trading. Worries about deteriorating global economic conditions have also bolstered safe-haven demand for the dollar. As of the latest update, the U.S. Dollar Index was trading at 104.8. This index measures the dollar’s value relative to a basket of other significant currencies including the Euro, British pound sterling, Swedish krona, and Japanese yen.

The recent upswing in the index means that individuals looking to fulfill foreign exchange payment commitments via dollar transfers to regions like Europe and Japan would require fewer dollars to do so. Treasury rates with shorter maturities, which are more sensitive to shifts in the Fed’s rate, saw an increase of several basis points on Wednesday. After rising by over 6 basis points to 5.02%, the two-year yield hovered around 5.01%.

Overnight data release indicated that activity in the U.S. services sector exceeded expectations in August, with the sector’s price index continuing to climb. These figures have raised concerns about persistent short-term inflation, prompting the Fed to maintain a hawkish stance.

A number of Fed officials are expected to speak this week, providing further insight into monetary policy ahead of the month-end rate decision. While it’s widely anticipated that the Fed will keep rates steady, they are likely to reiterate their commitment to sustainable rate hikes.

The robust U.S. labor market gives the U.S. Fed additional tools to combat inflation, increasing pressure on frontier market currencies like the Nigerian naira, as investors are increasingly turning to safe-haven currencies.

At present, the dollar remains at the core of the global financial system, and U.S. Treasuries continue to be the preferred safe haven. In the SWIFT payment system, the share of dollar transactions exceeds 40%, solidifying its dominant position. The euro accounts for approximately 25%, while the yuan’s share is around 3%. In early 2023, the dollar’s share of foreign exchange reserves reached a record 58%, compared to 73% in 2001.

Despite the ongoing shift away from the dollar, it’s unlikely to occur rapidly. According to a recent report from JPMorgan economists, while some “marginal de-dollarization” is occurring, it won’t be a swift process. The dollar, despite its imperfections, is deeply ingrained in global transactions, making a rapid transition to another currency improbable.

Nairametrics

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