Macroscope | A strong US dollar could bring Asia more pain, especially if Trump wins

The prospect of ‘higher for longer’ interest rates and a ‘stronger for longer’ US dollar has hit Asian markets particularly hard, with Japan an extreme example

The only way the dollar will fall meaningfully is if the US economy slows sharply and the Fed cuts rates sooner and at a faster pace than markets expect

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A man walks past an electronic screen displaying a graph showing a surge in Japanese yen exchange rates against the US dollar, amid signs of intervention by Japanese authorities, in Tokyo on May 2. Photo: Reuters

Published: 6:30pm, 9 May 2024Updated: 7:53pm, 9 May 2024

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.