A new sovereign debt crisis?
The strength of the dollar could lead to a sovereign debt crisis. While the US dollar has been the one consistent winning trade of 2022, it could force several countries hit by economic hardship to default on their debt.
As economic conditions continue to deteriorate and a global recession looks near, investors have steadily flocked to the dollar and dollar-denominated assets. The Fed has been raising interest rates sooner and steeper than other major global central banks and that’s only helped strengthen demand for the greenback, which is bad news for holders of dollar-denominated debt.
Most sovereign governments borrow in U.S. dollars, especially emerging markets. While interest rates are raised rapidly to stifle inflation, borrowing costs become more expensive and debt burdens even larger. For countries whose governments are already swimming in debt, this can be the factor that pushes them over the edge. Sri Lanka has already defaulted and could be followed by countries like Ecuador and Egypt. Larger economies like Argentina and Pakistan could be next.