Fed Surprise May Herald New Era of Asian Currency Weakness

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A hawkish surprise from the Federal Reserve is exacerbating declines in emerging Asia currencies, potentially heralding a longer bout of weakness.

Almost all developing Asian currencies were lower against the greenback after the Fed released forecasts that showed officials anticipate two interest-rate increases by the end of 2023, sooner than many thought. The South Korean won fell as much as 1.5% to pace declines in the region while the Chinese yuan, Indian rupee and Indonesian rupiah each dropped at least 0.5%.

The losses could mark the start of a new era of declines in emerging Asian exchange-rates, which have already fallen this month amid speculation the Fed may soon begin winding down its bond-buying program. Higher U.S. yields and a stronger dollar are likely to reduce the popularity of carry trades, which had bolstered demand for regional debt.

“The prospects of a calm carry collection summer seem to be somewhat challenged,” Citigroup Inc. strategists including Gaurav Garg wrote in a note. “Even as Asia is in a better position compared to that last episode of taper chatter in 2013, it is not immune to spillovers from higher U.S. rates and stronger USD.”

Fed Surprise May Herald New Era of Asian Currency Weakness

The benchmark 10-year yield in the U.S. gained eight basis points on Wednesday in the wake of the Fed decision and is expected to climb even further, analysts say. This will reduce the premiums investors get from buying Asia government debt, reducing their appeal to global funds.

“Despite Powell’s advice to take the dot plot ‘with a big grain of salt’, concerns about inflation are still brought back to the fore,” said Fiona Lim, a senior currency strategist at Malayan Banking Berhad in Singapore. This could “keep the UST yields elevated and weigh on Asian currencies in the near term, particularly those who have benefited from carry trades,” she said.

Still, some note that Asia’s economic fundamentals have improved since the selloff in 2013, providing a buffer for regional exchange rates.

“Unlike previous taper tantrums, the Fed’s assurance for a more transparent and orderly adjustment to policy should help limit the Asia FX selloff,” said Trang Thuy Le, Asia FX strategist at Macquarie Capital Ltd. in Hong Kong. Currencies such as the rupee, rupiah and Philippine peso are also backed by improved current-account positions and ample reserves, she added.

Volatility Rises

Even before the Fed decision, emerging currencies had come under pressure with a gauge of implied volatility rising for the first time in two weeks on Monday. Gains in the South African rand -- this year’s best performer -- have stalled while options traders are adding to bearish wagers on the Russian ruble.

The MSCI Emerging Markets Currency Index fell 0.7% Thursday, its biggest one-day decline in more than three months, while the Bloomberg Dollar Spot Index rose to a two-month high.

“What matters for EMs is not as much the U.S. inflation numbers themselves, but rather the Fed’s indications about its future behavior,” Credit Agricole strategists led by Sebastien Barbe wrote in a note. “Markets could also move when the Fed moves closer to taper talks. At such a point in the future, the most vulnerable EM currencies could weaken further.”

©2021 Bloomberg L.P.

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