Last month it was so hot the swifts abandoned the skies. Imagine flying all of the way from South Sahara only to discover that your holiday home is hotter than Cairo.

Just like global temperatures, interest rates have been climbing around the world as policymakers attempt to reign in rising prices.

All eyes are fixed on the US Federal Reserve and economists expect the rest of the world to follow their hikes. Many countries have much less leeway though – Europe, is suffering from the supply shocks related to Russia’s invasion of Ukraine and even China is struggling with their economy growing at the slowest rate in 30 years in the second quarter.

The Dollar Doom Loop

The dollar lubricates the global economy. It is one side of about 90% of all foreign exchange transactions, accounting for around $6 Trillion in activity every day.

Fears of recession coupled with the rate hikes has boosted the value of the dollar against other currencies. One of the potential consequences of a strong dollar is that it slows down economic activity, which in turn makes the dollar even more expensive.

Why is a strong Dollar bad for the rest of the world?

As the main global currency for trade, a strong dollar raisesthe prices of imports and raisesthe cost of servicing external debt.

As the cost of borrowing rises, highly indebted countries (like Sri Lanka) are hit particularly hard. Even the rich countries that have enjoyed very low interest rates for the last decade get squeezed. Debt payments in European countries such as Greece and Italy are rising quickly, reminiscent of the sovereign debt crisis following the 2008 crash.

The Vicious Circle

The key problem is that central banks must use monetary policies to tackle inflation…. which leads to economic deterioration…. which results in political pressure to back off (can you see the irony?). This was the situation in the late 70s and early 80s when, each time the foot lifted off the brakes, inflation kept springing back.

The situation was only brought under control when there was sufficient political commitment and Paul Volkler was appointed as chairman of the US Federal Reserve with a mandate to stamp out inflation ‘at all costs’.

Looking across the current political landscape (Europe and US) there doesn’t appear to be a Paul Volkler in charge of the finances nor any political leaders with sufficient conviction to stay the course.

Commodity prices everywhere are dropping

The early signs are that the global economy is slowing as these measures start to bite. Oil is just one of many commodities falling after skyrocketing in price. Copper, the metal that’s seen as the best gauge of economic activity because it’s used in many different types of products, has dropped to a 17-month low over recession concerns. It’s on the brink of a bear market, and every recession of the last 30 years has followed a bear market in copper.

Remember, Stock markets are not economies (and vice versa). We’ve already highlighted that the next eighteen months or so will be volatile, and our advice is still to ignore the noise and sit tight. We cover some other issues in our Summer newsletter, including the impact of inflation on investment returns.

As always, please do not hesitate to contact us if there’s anything you would like to discuss further.