US dollar strength is not playing well in many countries, but it doesn’t seem to be an issue for US President Joe Biden’s administration. “A market-determined value of the [US] dollar is in America’s interests,” US Treasury Secretary Janet Yellen said on October 11, adding that the
current strength of the US currency is the “logical outcome” of different monetary policy stances globally.
In Hong Kong, the
linked exchange rate system and the efforts of the Hong Kong Monetary Authority keep the Hong Kong dollar in a range of HK$7.75 to HK$7.85 to the US dollar. This shields Hongkongers from untrammelled US dollar volatility.
From Beijing, the People’s Bank of China (PBOC) continues to focus on the need for yuan stability. However, even the PBOC felt the need last week to emphasise that it would “take comprehensive measures, stabilise expectations [and] resolutely curb big ups and downs in exchange rates,” adding that it would act to “keep the yuan basically stable on a rational, equilibrium level”.
The PBOC will subsequently have noted that last Thursday saw yet more evidence that US consumer price inflation (CPI) remains stubbornly elevated despite a succession of US Federal Reserve
interest rate increases that themselves have already underpinned the US dollar’s broad rise on the currency markets this year.
Core US CPI, an inflation measure that excludes volatile food and energy prices, rose by 6.6 per cent year on year in September, in part driven by a substantial increase in property rental costs. The year-on-year increase in
core CPI was the largest since August 1982.
Such evidence of “sticky” US inflation only reinforces the case for the Fed to unveil another increase of 75 basis points in US interest rates on November 2, with a further increase likely on December 14. That should continue to provide a tailwind for the US dollar, but it raises the question of how other jurisdictions cope with that.
As it is, other countries have already seen their own currencies plummet in value versus the US dollar. Much to Tokyo’s chagrin,
the Japanese yen has this year hit multi-decadal lows against the US dollar and, by extension, the Hong Kong dollar.
Consequently, with the LERS limiting how far the Hong Kong dollar can depreciate versus the US dollar, Hongkongers who have
travelled to Japan recently after the Japanese government’s removal of pandemic-related entry restrictions have not only enjoyed a well-deserved break but also found a bargain.
With the Bank of Japan resolutely sticking to an ultra-accommodative monetary policy – a stance that only makes the contrast with the Fed’s tightening even starker – Japan’s Ministry of Finance has tried unilateral intervention on the foreign exchanges in an attempt to stem the pace at which the yen is weakening versus the US dollar.
India has also resorted to intervention this year in defence of a rupee that has come under selling pressure versus the US dollar. The problem is that generating cash for the purpose of intervening on the foreign exchanges can logically be seen by the markets as involving the prior
selling of US Treasuries, a major constituent in many countries’ foreign reserves.
As markets can infer that such Treasury sales can only weigh on US government bond prices and so push up Treasury yields, the risk is that such attempts to generate US dollars for intervention ultimately merely exacerbate the problem. After all, higher Treasury yields were already a key driver of the very US dollar appreciation that
these interventions seek to address.
Admittedly, while it is no small matter when countries such as India and Japan intervene on the foreign exchanges, if China followed suit then the implications for US Treasury prices and yields would be greatly magnified. A doom loop of falling Treasury prices and higher Treasury yields prompting more interventions that then result in yet higher yields could ensue.
So far, and perhaps in recognition of this kind of risk, the PBOC seems inclined to use policy tools other than intervention to create
yuan stability.
In reality, and economic decisions emerging from this week’s
Communist Party congress will matter in this regard, the key to investor confidence in China’s currency will ultimately derive from investors’ faith both in China and in the prospects for the renminbi going forward as a store of wealth.
The drivers of US dollar strength remain intact and many countries’ currencies are exposed. But China’s economic heft and Hong Kong’s linked exchange rate system provide the yuan and the Hong Kong dollar with protection against unconstrained US dollar volatility. In febrile markets, that’s reassuring.
Neal Kimberley is a commentator on macroeconomics and financial markets
