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Macroscope | Risk of Asian currency crisis remains low even amid US dollar strength and economic worries
- Asian and G10 currencies are likely to continue to weaken against a strong dollar as the Fed stays hawkish on inflation
- But fundamentals are solid in Asia and real interest rates in most economies remain above those in the US, which will support local currencies
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The strength of the US dollar has been palpable this year, with the currency rallying about 20 per cent, retesting 20-year highs. The pain felt across G10 nations has been most acute in Japan and the UK, with the yen and pound some 20 per cent weaker, while the euro is down 15 per cent.
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Other Asian currencies have weakened but remained largely resilient compared to the G10 currencies, apart from those commodity-linked ones such as the Canadian and Australian dollar, and Swiss franc. Widely considered a safe haven, the Swiss franc has lost nearly 8 per cent.
A strong dollar is a double-edged sword. For the US, it makes imports cheaper and relieves pressure from imported inflation, but also hurts exports since these become more expensive for overseas customers. For the rest of the world, a weaker local currency may boost export competitiveness but it also brings worries about imported inflation, especially for those reliant on energy and food imports.
A strong dollar traditionally triggers capital outflows from emerging economies. With the risk of financial instability, local central banks have often been cornered into following the US Federal Reserve in raising interest rates aggressively to defend their currencies.
As currency markets are essentially a zero-sum game, a weaker and more stable dollar would be a relief for the rest of the world. But it is still an open question as to when the dollar will peak.
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There are two key reasons for dollar strength this year. First, interest rate differentials have widened between Treasuries and the government bonds offered by other developed markets as central banks lagged behind the Fed’s hawkishness. This drove demand for Treasuries and pushed up the dollar.
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