The Fed has the world in its hands — and its aggressive moves are creating global economic chaos that could come back and hurt the US

The Fed has the world in its hands — and its aggressive moves are creating global economic chaos that could come back and hurt the US
Fed chair Jerome Powell has spoken out in favor of aggressive interest rate hikes to bring inflation under control.Kevin Dietsch/Getty Images
  • The Federal Reserve's aggressive rate hikes have the world's central banks scrambling to keep up.
  • A strong dollar puts others in a lose-lose: fight inflation and slow growth, or allow prices to continue surging.

As the US dollar grows stronger, that comes at the expense other currencies around the world.

And the dollar has been getting a whole lot stronger through the back half of 2022 as the Federal Reserve has enacted historically large interest-rate hikes to fight inflation. The rally has placed central banks around the world in a race to see who can lift interest rates — and, by extension, the value of their money — faster to keep up.

As it stands now, the Fed still commands a healthy lead — a designation that raises the stakes for any further policy moves it makes.

And while the ongoing "reverse currency war" might sound like good news for the US, the nature of the modern global economy means that slowdowns abroad can hurt at home.

Today, it leaves the Fed with a difficult choice. Ending the hiking cycle would alleviate pressure on other countries to raise rates, but could doom the US to persistently high inflation.


On the other hand, moving forward with aggressive tightening would help curb soaring prices in the States, but it also slams the brakes even harder on economic growth. That would raise the risk of a recession in the US, complete with widespread layoffs, weak wage growth, and plunging investment balances.

US policy has the rest of the world scrambling to keep up

On September 21, Fed Chair Jerome Powell reiterated that the central bank won't stop raising rates until "the job is done." With jumbo-sized rate hikes likely, major economies like the UK, Japan, and China are vulnerable to a prolonged economic downturn. Since their currencies are already weakening against the dollar, those countries either need to hasten their rate hikes and risk recession or allow the dollar to strengthen further and diminish their own currencies' values.

As a result, more than 80 central banks around the world are following the Fed's lead. They are continuing the tightening plans that kicked off earlier this year and moving aggressively to cool their own unique kinds of inflation.

Yet there's little coordination between policymakers. Instead of officials working in harmony to tame global inflation, central banks are rushing to prop up their own currencies as fast as possible.

In the UK, the new Conservative government cooked up a tax-cutting plan meant to juice the economy amid fears of an imminent slowdown. But the proposal clashed so violently with the economic consensus that it earned a rebuke from the IMF — and disrupted the Bank of England's rate-hiking efforts.


The pound plunged to a record low against the dollar and prices on gilts — the UK government's bonds — also nosedived as investors grew increasingly fearful of a ballooning deficit.

That led to the Bank of England announcing that it would start buying government bonds and delay its efforts to slash its balance sheet in a bid to stabilize debt markets. But the bank's repurchasing program will inject more cash into the UK economy at a time when inflation is already running at a red-hot 9.9%.

The alternative is no more appetizing. Failure to buoy the pound and ease the recent selloff could open the door to a steeper decline for the currency. That would dramatically lift prices for imports in a country that already buys nearly half of its food and most of its energy from other economies.

As prices soar higher across the UK, the country will creep ever closer to a severe recession. High inflation tends to curb demand as households cut back to preserve their finances. Weaker spending tends to lead to lower revenues, which in turn sparks layoffs and kicks off a vicious cycle of economic decline.

Other central banks are taking more forceful action to prop up their currencies against the dollar and avoid soaring import costs. With the yen trading close to 24-year lows, the Bank of Japan intervened to boost the currency's value earlier this month by dumping dollars and buying the native currency, marking the first time since 1998 that Tokyo directly intervened in the currency market.


Japan — which has historically struggled with deflation, rather than inflation — isn't seeing prices soar at the same rate as countries like the US and the UK.

But there are signs that pressures are starting to build. Import volume surged by almost a third over the past year, according to Deloitte. The yen's depreciation makes those imports more expensive, pushing inflation higher.

The Bank of Japan has indicated that it will use monetary policy to prop up the yen if a freefall threatens price stability, but the interest rate hikes needed to do so could cause growth to stagnate.

The People's Bank of China has also worked to bolster the renminbi, currently on course for its worst year since 1994. It has told major state-run banks to prepare to dump their dollar holdings while loading up on offshore yuan.

But China's banks would be made to tighten their balance sheets at a time when economic growth is slumping. Beijing's 'zero-Covid' approach to pandemic lockdowns has led to a sharp decline in business activity, and the government recently slashed its annual GDP projection to 2.8% — just over half its 5.5% target.


The Fed didn't force China to continue locking down its population, just as Jerome Powell isn't responsible for the UK Conservative Party's tax-cutting proposals. But its aggressive rate hikes are fuelling a global sense of economic confusion as other central bankers look to defend their currencies against the surging dollar.

"Recent tightening of monetary and fiscal policies will likely prove helpful in reducing inflation," Ayhan Kose, the acting vice president for equitable growth, finance, and institutions at the World Bank, said in a recent report. "But because they are highly synchronous across countries, they could be mutually compounding in tightening financial conditions and steepening the global growth slowdown."

While the US leads the way for now, its dominance can quickly backfire

The Fed isn't yielding in this game of central-bank chicken. Projections published on September 21 suggest policymakers will raise interest rates by another 1.25 percentage points before the end of the year and continue to hike through 2023.

Powell has hinted that the Fed will err on the side of overtightening, meaning he prefers to risk a recession than let inflation run unchecked. The chair repeatedly mentioned in his September 21 press conference that a period of subpar growth and higher unemployment is likely necessary to balance out the economy and cool inflation. And in his annual speech in Jackson Hole, Wyoming, Powell highlighted the benefits of fighting inflation forcefully to avoid worse fallout later on.

"History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting," he said.


But Powell seems to be taking a "soft-ish landing" scenario — when rate hikes only lead to a moderate economic slowdown — for granted. If other central banks are forced to hike aggressively to keep pace with the dollar's appreciation, then his hawkish statements could fuel global growth recessions that come back to bite the US.

The US relies on imports to maintain a steady supply of goods like food, crude oil, and car parts — and the price of those goods is directly connected to the performance of other global economies.

Take China as an example. If Beijing's efforts to prop up the yuan against the dollar tip the Chinese economy into a growth recession, manufacturing and industrial activity are likely to fall. That would mean China produces less of the goods it tends to export to the US — such as aluminum, glass, and wood.

Import prices would likely rise as supplies of those goods fall. American importers would be left with a choice between passing those higher costs onto consumers or seeing their profit levels take a major hit — with either route contributing to a harsher recession.

What started as an effort to contain US inflation will have suddenly become a dire global slump.