South China Morning Post
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A man contemplates his next move as he plays chess in Hyde Park Sydney, Australia, on August 11. In the current chess match among central banks, the US Federal Reserve’s ability to shape the global policy context makes it the grandmaster. Photo: AP
Opinion
Macroscope
by Neal Kimberley
Macroscope
by Neal Kimberley

Asian central banks are locked in a losing chess match with the US Federal Reserve

  • Asian central banks facing currency weakness are stuck with no good moves as the Fed presses forward with interest rate increases and quantitative tightening
  • Short of a dramatic reversal of the market’s current bullish view of the US dollar’s prospects, China’s central bank might be limited to managing the rate of descent of the yuan versus the US currency
Neal Kimberley
Neal Kimberley
Why you can trust SCMP
The year 1972 saw the legendary chess duel in Reykjavik between the Soviet Union’s Boris Spassky and Bobby Fischer of the United States. Half a century on, Asian central banks find themselves locked in a monetary policy chess match with the US Federal Reserve that is being played out on the foreign exchanges.
Asian central banks seeking to address local currency weakness in the face of Fed-related US dollar strength are essentially in zugzwang, a chess term applied when a player has nothing but bad options available.
Slow to recognise the danger from higher US consumer price inflation, the Federal Reserve has now enthusiastically taken the offensive. Interest rate increases and the initiation of quantitative tightening will see the Fed’s balance sheet shrink as it removes liquidity from the US monetary system.

Only reinforced by the US jobs report last week, more US rate increases are in the offing. The Fed is likely to keep those rates higher for longer as it seeks to checkmate elevated inflation.

Another rise in US interest rates seems almost certain on September 21, the only question being if it will be a further 0.75 per cent move or “just” 0.5 per cent. As for quantitative tightening, how that ultimately plays out is as yet unclear, but it has to make US monetary policy more restrictive in the same way that quantitative easing was expansive.

01:36

US Federal Reserve authorises another big rate hike in bid to curb inflation

US Federal Reserve authorises another big rate hike in bid to curb inflation
Meanwhile, the Biden administration has pushed through expansionary fiscal legislation, not least the recent US$430 billion Inflation Reduction Act. In currency market terms, and today is no exception, tighter US monetary conditions and looser US fiscal policy often equate to marked US dollar strength.
Last week, that strength saw the US dollar-Japanese yen and the US dollar-Korean won exchange rates reach levels not seen for years. The dollar-yen rate moved above 140 for a new 24-year high while the dollar-won rate topped 1,357, a level not seen since April 2009.

Yuan weakness against the US dollar was less pronounced. The People’s Bank of China (PBOC) successively set midpoint rates for the dollar-yuan exchange rate last week that were numerically lower than market expectations, allowing some weakening of China’s currency against that of the US but less of a slide than the yen and the won experienced.

It could be that the PBOC had yuan stability in mind. That is a key policy objective for Beijing, not least ahead of China’s 20th Party Congress on October 16.
But it is no easy matter for the PBOC to restrain renminbi weakness that is in large part a function of broad US dollar strength, especially when markets understand that China’s own economic challenges require steady-to-easier monetary policy even as the Federal Reserve is raising US interest rates at pace.
Unless there is a dramatic reversal of the market’s current bullish view of the US dollar’s prospects, the PBOC’s role might be limited to managing the rate of descent of the yuan versus the US currency rather than halting it.

Japan faces a similar quandary. The yen’s pronounced weakness is, to a large degree, a consequence of higher US interest rates and continuing Japanese ultra-accommodative monetary policy, but that doesn’t mean Tokyo is comfortable with it.

“Excessive, disorderly currency moves could have a negative impact on the economy and financial conditions,” Japan’s Finance Minister Shunichi Suzuki said on Friday. “We will respond appropriately as needed, working closely with authorities of other countries.”

Is the falling Japanese yen cause for concern?

The problem is that when the Japan-US interest rate differential is so heavily in favour of the US dollar over the yen, such verbal intervention is not worth the paper it is not written on. Moreover, if Japan’s Ministry of Finance does authorise the Bank of Japan to intervene to buy yen for US dollars while the dollar-yen exchange rate is trending higher, that would just give speculators better levels to pick up US dollars.

As for the prospect of coordinated action with the US authorities, never say never, but the disinflationary effect of a strong US dollar might currently suit Washington.

Over in Seoul, the Bank of Korea might not be overjoyed at the extent of won weakness versus the US dollar, but governor Rhee Chang-yong is realistic. “We are now independent from government, but we are not independent from the Fed,” Rhee said on August 28. “So if the Fed continues to increase the interest rate, it will have a depreciation pressure for our currency.”

Quite so. In the endgame of this current central bank game of chess, the Federal Reserve is the grandmaster.

Neal Kimberley is a commentator on macroeconomics and financial markets

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