The Galloping Greenback | Recent Strengthening of the US Dollar

The Fastest Tightening | Introduction

In March 2022, the US Federal Reserve raised the target range for the Federal Funds Range by 25 basis points or 0.25%, putting an end to the near-zero interest rate policy put in place around the start of the Covid-19 pandemic. In the 16 months that followed, the Federal Reserve implemented rate hikes totaling 500 basis points, taking the Federal Funds Range to 5.25%-5.50% by July 2023. This was the fastest policy rate tightening cycle the Federal Reserve conducted in nearly four decades.

The US Dollar Index (DXY) appreciated considerably in the months following the initiation of the policy rate tightening major, reflective of major world currencies witnessing sharp declines in their respective values relative to the US dollar throughout 2022. Back home, the US dollar crossed the mark of ₹80 in India by September 2022. Despite 100 basis points in rate cuts implemented by the Federal Reserve since September 2024, the Indian rupee (INR) has seen a steady decline versus the US dollar. The Indian rupee hit an all-time low per US dollar in February 2025.

Fall and Fall | Reasons for the Falling Rupee

After breaching the level of ₹84 per US dollar in October 2024, the Indian rupee has navigated a further depreciation of over 3%. The sustained decline in the Indian rupee has been driven by an increasing demand for the US dollar and USD-denominated assets. This preference is reflected in the significant outflows from the Indian markets driven by Foreign Institutional Investors (FIIs). The following reasons can be attributable to the FII sell-offs across Indian equities:

– Strengthening of the US Dollar

The US dollar has outperformed major world currencies on the back of sustained consumption-driven growth of the American economy and the higher-for-longer rate policy by the Federal Reserve. The depreciation of the Indian rupee resulted in local currency India returns becoming less attractive to foreign investors when measured in USD terms. The US Federal Reserve is expected to carry out fewer than previously anticipated rate cuts in 2025 and 2026. This will likely maintain the current strength of the US dollar against the Indian rupee and other currencies.

– Elevated US Treasury Bond Yields

The treasury yield curve in the US experienced consistent inversion from November 2022 following the initiation of rate hikes by the Federal Reserve. Ultra short-term US treasury bonds in the US traded consistently above 5% yield-to-maturity after March 2023, with the yields moderating around the first rate cut by the Federal Reserve in September 2024. It may also be noted that despite the Federal Reserve cutting rates by 100 basis points last year, longer-duration treasury yields in the US rose by 50-75 basis points. The narrowing spread between the US and Indian treasury yields made Indian assets less attractive in the near term, exerting downward pressure on the Indian rupee.

– Geostrategic Considerations

Likely tariff-related policies of the Trump Administration and the retaliatory measures expected from other nations have resulted in a heightened uncertainty among international investors, leading them to seek safe-haven assets like the US dollar and gold. Consequently, the Indian rupee and other emerging market currencies have faced depreciation pressures due to reduced investor confidence and capital outflows.

– Widening Trade Deficit

The trade deficit of India widened to a record USD 37.8 billion in November due to a considerable rise in gold imports and a decline in exports [1]. The growing deficit has heightened demand for US dollars to settle international transactions, further exacerbating a downward pressure on the rupee.

A combination of the above factors has weighed on the Indian rupee which has witnessed a sharp decline in its value against the US dollar in recent months.

Leading the Pack | US Dollar versus Major World Currencies

Major world currencies have witnessed moderate to sharp declines in their values relative to the US dollar since 2022 and throughout 2024, with the said declines continuing to date:

– Euro (EUR)

The euro has faced downward pressure, with a growing number of forex strategists predicting it will fall to parity or below against the dollar in the near term. Factors contributing to this trend include economic challenges within the Eurozone and the strength of the US dollar. Also, the European Central Bank is projected to cut its policy rates multiple times this year. This will likely contribute to further weakening of the euro against the US dollar.

– Canadian Dollar (CAD)

The Canadian dollar has declined against the US dollar, particularly since October 2024, primarily due to rising uncertainty around the trade policies of the Trump Administration. A widening differential in policy interest rates between the two countries has also played a modest role in this depreciation [2], given the recent rate cuts by the Bank of Canada.

– British Pound (GBP)

The British pound has weakened against the US dollar amid concerns over the economic outlook of the United Kingdom. The recent interest rate cut by the Bank of England from 4.75% to 4.5%, aimed at stimulating a sluggish British economy, has contributed to the depreciation of the British pound. Additionally, the downgraded growth forecasts and potential inflationary pressures have further weighed on investor confidence, reflected in the declining value of the British pound.

– Japanese Yen (JPY)

The Japanese yen saw a depreciation relative to the US dollar during 2022-2024 due to a combination of aggressive rate hikes by the Federal Reserve and a negative interest rate policy maintained by the Bank of Japan. The Bank of Japan ended the negative interest policy in March 2024 and carried out rate hikes in the months that followed, leading the Japanese yen to appreciate against the US dollar for a brief period. However, expectations of a hawkish Federal Reserve policy reversed the gains leading to a depreciation of the Japanese currency.

While the Japanese yen has shown resilience, other major currencies are expected to continue declining relative to the US dollar in the near term. This trend is primarily due to relatively higher rate cuts by their respective central banks compared to the Federal Reserve.

Dollar Supremacy | Conclusion

The recent strengthening of the US dollar has intensified the global preference for USD-denominated assets by investors globally. Historically, the US dollar has also played a major role in the allocations of global institutions due to its dual role as the dominant currency in international trade and as a reserve currency for central banks. For example, the US dollar made up around 90% of the total global FX transaction volume in 2024. Also, nearly 48% of all international SWIFT payments were denominated in US dollars. [3]

This enduring dominance of the US dollar underscores its firm and deep integration with the global financial system, reinforcing its status as the primary medium of exchange and store of value for the world.

References

[1] The Wire Staff. (Updated 2024, December 17). India’s Trade Deficit Swells to Record $37.8 Billion in November. The Wire. – https://thewire.in/economy/indias-trade-deficit-swells-to-record-37-8-billion-in-november

[2] (Updated 2025, January 29). Recent factors affecting the Canada-US exchange rate. Bank of Canada. – https://www.bankofcanada.ca/publications/mpr/mpr-2025-01-29/in-focus-2/

[3] Buchholz, Katharina. (Updated 2025, January 22). U.S. Dollar Defends Role as Global Currency. Statista. – https://www.statista.com/chart/30838/share-us-us-dollar-in-global-economy-global-financial-transactions/

Disclaimer: “Any views or opinions represented in this blog are personal and belong solely to the author and do not represent views of CFA Society India or those of people, institutions or organizations that the owner may or may not be associated with in professional or personal capacity, unless explicitly stated.”

About the Author

Mihir Shirgaonkar, CFA heads the Alternative Investments division at Phillip Ventures IFSC Pvt. Ltd. and has been a part of the firm since 2021. He is a chartered accountant and has completed MBA-PGPX at the Indian Institute of Management Ahmedabad. He has over 10 years of asset management experience and has worked with DSP Investment Managers (erstwhile DSP BlackRock) and HDFC AMC in his previous roles. In his career so far, he has handled multiple areas which span portfolio management, market making, valuations, fund administration, and project management. His other interests include philosophy, reading, photography, trekking, coding, cooking, and travelling.