Rising US dollar raises alarm as China, Japan escalate FX decline

(Bloomberg) – The renewed appreciation of the US dollar has pushed Asian currencies to multi-month lows while prompting authorities in Japan and China to step up defenses of their troubled exchange rates.

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Japan issued its strongest warning in weeks of a rapid decline in the yen on Wednesday, with its top currency official saying the country stands ready to take action amid speculative moves in the market. Shortly thereafter, the People’s Bank of China issued its most aggressive daily reference rate forecast for the yuan as the managed currency weakened to levels not seen since 2007.

Robust US economic data is convincing some traders that the Federal Reserve will keep interest rates higher for longer, sending the dollar and an index of Asian currencies to their lowest levels since November. That means regional policymakers, who spent last year depleting their reserves to prop up local currencies, are back on the battlefield to take on pessimistic speculators.

“The prospect of higher US interest rates for longer is adding pressure and investors will remain cautious,” said Vijay Kannan, macro strategist at Societe Generale SA in Singapore. “Emerging Asia, in particular, is more vulnerable to this dollar strength as the interest rate differential is much narrower and they are more exposed to China’s weaker growth prospects.”

Higher oil prices have also reignited fears of higher inflation, a move that undermines expectations that Asian central banks have raised interest rates and reduced the appeal of local currency bonds. Bonds in Indonesia and Thailand are both seeing outflows from abroad this month.

The story goes on

China’s gloomy economic outlook, based on months of disappointing data, is also weighing on sentiment towards emerging market currencies.

The Yen and Yuan were among the worst performing currencies in Asia this year. While Japan has refrained from using more aggressive tools to support its currency, China has already sought to strengthen the yuan by encouraging state-owned banks to sell dollars while tightening offshore liquidity to stifle short-currency bets.

Similar currency defense measures exist elsewhere in Asia. Taiwan’s foreign exchange reserves fell in August for the first time in almost a year as the monetary authority intervened in the market. And in Thailand, the central bank has warned that rapid moves in the baht will prompt intervention.

However, skepticism remains as to whether these measures will be game-changing unless the Fed eases up or the Chinese economy tightens. Morgan Stanley was bearish on emerging market currencies this week, saying that Asian currencies would be hit by a slowdown in China growth.

“The immediate impact of the strengthening US dollar is that it will prevent most Asian central banks from easing monetary policy amid fears of deepening currency weakness,” said Alvin T. Tan, head of currency strategy for emerging markets at RBC Capital Markets Singapore.

– With support from Ruth Carson and Neha D’silva.

(updates with analyst commentary)

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