Is this all US$60 billion worth of central bank interventions in global foreign exchange markets buys you these days? It is a question that is undoubtedly preying on the minds of Japanese policymakers as an analysis of the accounts of the Bank of Japan (BOJ) indicates they deployed tens of billions of dollars last week to prop up the yen after the currency fell to a fresh 34-year low against the US dollar.
Having strengthened 3.3 per cent versus the US dollar last week, the yen has resumed its decline, sliding back towards the 160 per dollar level that triggered the suspected intervention. It is down more than 10 per cent against the dollar this year, taking its losses during the past three years to a staggering 43 per cent.
That Japan’s currency continues to weaken, despite the BOJ’s momentous decision in March to raise borrowing costs for the first time since 2007, speaks volumes about the forces driving currency markets.
Interest rate differentials are the only game in town right now. Benchmark rates in the United States are at 5.25 to 5.5 per cent versus 0 to 0.1 per cent in Japan, increasing the appeal of investing in higher-yielding US dollar-denominated assets. Moreover, bets that the US Federal Reserve would cut rates this year have been scaled back dramatically, underpinning a sharp rally in the US dollar since mid-March.
The US currency’s strength reflects the resilience of the country’s economy, especially the its persistently tight labour market. A stronger economy means more inflationary pressure. Progress towards the Fed’s 2 per cent inflation target has stalled, with the central bank’s preferred gauge of prices reaccelerating in the first quarter of this year.
The prospect of “higher for longer” interest rates and a “stronger for longer” US dollar has hit Asian markets particularly hard. The yen is the most extreme example of a region-wide vulnerability. With the exception of India, interest rates in Asia’s main economies are significantly lower than in the US, unlike in Latin America and Eastern Europe, where borrowing costs in the leading markets remain higher despite the start of monetary easing cycles.
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Japanese monetary authorities mull intervention options after yen drops to 34-year low
Japanese monetary authorities mull intervention options after yen drops to 34-year low
This puts Asia at a disadvantage, especially when hopes that the Fed would cut rates this year have faded. HSBC notes that “lower-yielding Asian currencies are bearing the brunt of the repricing of [US monetary policy]” as investors “focus on the relative level of interest rates”.
Asian currencies, including the Malaysian ringgit and the Thai baht, are being used as funding currencies in “carry trades”, putting them under strain when they are sold to carry out purchases of higher-yielding currencies such as the US dollar.
Even Asian markets with higher borrowing costs have suffered. The Indian rupee has fallen to a record low versus the US dollar while Indonesia’s central bank unexpectedly raised rates last month to defend the rupiah. Weak exchange rates amplify the impact of the recent rise in oil prices – a bigger threat to Asia given the region’s status as a net energy importer – and fan inflationary pressures.
The plunge in the yen has focused attention on the yuan, a regional currency anchor. While a sudden 2015-style devaluation is unlikely, given bitter memories of the loss of confidence and capital flight the surprise policy move engendered, the strong US dollar has accentuated Beijing’s conflicting priorities.
Loosening monetary policy further to counter the downturn while simultaneously maintaining financial stability, easing trade tensions and keeping the yuan relatively stable looks like a bridge too far.
To be sure, parts of Asia’s economies benefit from the rally in the US dollar. Companies that derive a large share of their revenues from exports to the US stand to gain from a stronger-for-longer American currency. Goldman Sachs notes that while 10 per cent of the revenues of companies in an index of Asian stocks that excludes China are from mainland China, 17 per cent are from the US.
Taiwanese, South Korean and Japanese firms have the highest sales exposure to the US, as much as 30 per cent in the case of Taiwan. This partly explains why the shares of Taiwan Semiconductor Manufacturing Company, the world’s largest contract chip maker, are up more than 40 per cent this year.
US Trade Representative Robert Lighthizer, centre, chats with Vice-Premier Liu He, right, at the Xijiao Conference Centre in Shanghai on July 31, 2019. Lighthizer and other former Trump administration officials are reportedly exploring ways to weaken the US dollar to reduce the country’s trade deficit. Photo: AP
However, a supercharged US dollar is a red rag to a protectionist bull, especially in the run-up to hugely consequential presidential election. Unlike US President Joe Biden, Donald Trump is very vocal about the value of the dollar, which he views through the prism of the persistent US trade deficit.
According to Politico, advisers to Trump led by Robert Lighthizer, the architect of the former president’s tariffs against China, are debating ways to weaken the US dollar. This is easier said than done. Trump’s threats to impose new tariffs, coupled with his penchant for tax cuts, are likely to strengthen the dollar, partly by fuelling inflation – which would make it more likely that the Fed would resume its tightening campaign.
What is clear is that Asia should not bank on a weaker US dollar if Trump recaptures the White House. The only way the currency is going to fall meaningfully is if the US economy slows sharply and the Fed cuts rates sooner and at a faster pace than markets anticipate. This is unlikely to happen this year. King Dollar will remain a source of angst for Asian policymakers for some time yet.
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