getty
The 5% rally in the dollar that Goldman Sachs expects this year could be dreadful news for Asia.
Past episodes of extreme dollar strength haven’t gone well for the most dynamic economic region. The most obvious example was the 1997-1998 Asian financial crisis.
That reckoning had its roots in the Federal Reserve’s 1994-1995 tightening cycle. At the time, the Fed doubled short-term interest rates in just 12 months. The resulting surge in the dollar made Asia’s currency pegs to the dollar impossible to maintain. First Thailand devalued in July 1997. Next Indonesia. Then South Korea.
Other episodes include the 2013 Fed “taper tantrum.” The turmoil prompted Morgan Stanley to publish a “fragile five” list on which no emerging economy wanted to be. The original group: Brazil, India, Indonesia, South Africa, and Turkey.
Now, a surging dollar is complicating Asia’s development plans anew. History’s greatest magnet is luring capital from every corner of the globe, hogging wealth needed to finance budget deficits, keep bond yields stable and support equity markets.
It’s depressing the Chinese yuan and Japanese yen just as Donald Trump prepares to return to the White House. Trump won’t be happy to learn that Asia’s top two currencies are trending lower versus a strong dollar.
Yet this dynamic is good for no one. Or as economists like Stephen Innes at SPI Asset Management put it, the “dollar’s dominance” is poised to act as an “economic wrecking ball” for an Asia region already on edge.
Exchange rate trends might increase Trump’s desire to devalue the dollar to gain U.S. trade advantage — or to try a Plaza Accord-like effort to alter currency trends.
A rising dollar might increase Trump’s desire to push the Fed to do his dirty work. Fed Chairman Jerome Powell is dreaming if he thinks his team can ignore Trump’s demands for lower rates this year. Powell folded during the Trump 1.0 era, adding liquidity to an economy that didn’t need it. Odds are, he will again as Trump 2.0 grabs the financial reins.
Goldman Sachs is hardly alone in predicting a further 5% jump in the dollar this year. Commodity Futures Trading Commission data find that investors — from big asset managers to hedge funds — are the most optimistic about the dollar’s upside since 2019.
And that’s in spite of how Trump and Chinese leader Xi Jinping end up getting along come January 20. It’s entirely unclear whether Trump 2.0 will prioritize trade deals over clashes. Or whether Trump will make good on the 60% tariffs he’s threatened.
Such predictions are also in spite of fiscal realities Trump will confront. Though Trump likes to talk of President Joe Biden’s spending, he added roughly $8 trillion to a national debt now topping $36 trillion between 2017 and 2021.
At present, only one of the top rating companies grades Washington AAA. And Moody’s Investors Service could yank this last one away, and quickly, if Trump pushes for fresh tax cuts. Or if U.S. lawmakers play games with raising the debt ceiling or shutting down the government.
Trump, meanwhile, might go too far in meddling with the Fed. One reason the dollar’s rise is accelerating is changing expectations for Fed rate cuts. Just two months ago, Team Powell seemed full-speed-ahead in lowering U.S. borrowing costs. A slew of strong data reports since then have the Fed delaying easing steps.
At the same time, Fed Governor Michelle Bowman said in a January 9 speech, inflation remains “uncomfortably above” the Fed’s 2% goal. “I supported the December policy action because, in my view, it represented the Federal Open Market Committee’s final step in the policy recalibration phase,” Bowman noted. She added that the Fed’s benchmark, now between 4.25% and 4.5%, represents “neutral” territory.
Shifting Fed expectations has the Bank of Japan making things up as it goes along. Just as the Fed has economists back at the drawing board, BOJ watchers have been caught off guard by shifting priorities in Tokyo.
On December 19, global markets were fully primed for a BOJ rate hike. Governor Kazuo Ueda stood pat instead. Part of the reason was fears of unnerving global markets. Ueda’s policy board may have worried that the BOJ tightening while the Fed isn’t adding liquidity might slam stock and currency markets everywhere.
U.S. rates staying higher for longer than Asia expected is complicating things at People’s Bank of China headquarters, too. As the dollar drifts higher, the Chinese yuan is under powerful downward pressure.
With China suffering deflation, there’s good reason to welcome a weaker exchange rate. Yet risks abound. A weaker yuan makes offshore debt harder to pay off, increasing default risks among property developers. Manipulating the exchange rate would set back efforts to internationalize the yuan. Also, it would enrage Trump World, increasing the scale of the trade war to come.
A runaway dollar, though, is perhaps the last thing Asia needs. As this wrecking ball swings anew, policymakers across the region had better batten down the hatches.
