A strong dollar is sending Asian currencies into a full-blown storm.

Whether it is the currencies of major Asian economies such as the Japanese yen, Indian rupee, and Korean won, or the small currencies of ASEAN countries such as the Indonesian rupiah, the Vietnamese dong, and the Philippine peso, they have all encountered a new round of selling pressure. Some currencies hit multi-month or even historical lows.

Goldman Sachs analyst Danny Suwanapruti pointed out in a recently released report that the US dollar is dominating Asian currencies. Asia's economic growth has picked up in recent months, inflation has slowed, and macro policy tightening should have further supported local currencies, but the dominant theme in macro markets is the Fed's policy path and its impact on U.S. benchmark interest rates and the dollar.

Goldman Sachs believes that the current expectations for the Federal Reserve to cut interest rates are in sharp contrast to the beginning of this year, opening up space for the U.S. dollar to rise further. When the U.S. dollar rises, the Korean won, Malaysian ringgit, and Indonesian rupiah are the most sensitive. If the U.S. dollar continues to rise, these currencies are at risk of depreciation. Maximum, Indian Rupee sensitivity reduced.

Media analysis pointed out that the strengthening of the U.S. dollar and the expectation that U.S. interest rates will remain high for a long time have reduced investor demand for emerging market assets, causing emerging market currencies to face depreciation pressure. Investors can earn substantial returns by holding U.S. dollars without taking on the additional risks of emerging market investing.

Mitul Kotecha, head of Asia foreign exchange and emerging market macro strategy at Barclays, said, "Most Asian currencies are having to succumb to the strength of the U.S. dollar. Driven by rising U.S. bond yields and rising risk aversion in the market, the U.S. dollar is generally in the foreign exchange market The strength has led to a decline in Asian currencies.”

Goldman Sachs predicts that when currencies depreciate sharply, the two central banks that will most actively defend their weak currencies are the central banks of Indonesia and the Philippines, because these two countries are economies with current account deficits, high inflation rates, and high levels of foreign debt. Depreciation may pose a greater risk to economic stability, and export-oriented economies with low inflation and current account surpluses (South Korea and Thailand) will be more tolerant of currency weakness.

Asian central banks need to act cautiously

Inflation has fallen in most Asian economies, creating conditions for central banks to cut interest rates. However, due to the pressure of currency depreciation, emerging market central banks dare not "act rashly." Interest rate hikes in most emerging countries have come to an end in 2023, but as the United States continues to postpone interest rate cuts, the more likely it is that emerging countries will postpone interest rate cuts or even turn to raising interest rates.

Morgan Stanley pointed out that if Asian central banks cut interest rates before the Federal Reserve, the currencies will be further under depreciation pressure, which may put upward pressure on inflation. Therefore, it is expected that Asian central banks will wait for the Federal Reserve to start cutting interest rates in June (the U.S. economic team’s baseline scenario ) before taking action.

A report released by the International Monetary Fund (IMF) shows that a stronger U.S. dollar will lead to capital outflows from these economies, higher import prices, and tightening of financial conditions. If the U.S. dollar exchange rate rises by 10%, the real GDP of emerging countries will rise one year later. (GDP) will decline by 1.9%, and the negative impact on the economy will last for more than two years.

In order to stabilize exchange rates, central banks around the world are taking action one after another.

Today, according to a statement from the South Korean Ministry of Finance, South Korean Finance Minister Choi Sang-mok and Japanese Finance Minister Shunichi Suzuki met (on the sidelines of the G20 spring meeting) and both were worried about the weakening of the Korean won and the Japanese yen. Two officials mentioned they might take action against erratic exchange rate fluctuations.

Bank of Korea Governor Lee Chang-yong said today that the recent weakening trend of the South Korean won is slightly excessive, and the Bank of Korea has the tools to take action in response to exchange rate fluctuations. Lee Changyong said in an interview with the media that the central bank is ready to take stabilization measures at any time and has sufficient resources to do so.

The Bank of Thailand once again kept policy rates unchanged at its latest monetary policy meeting to support the exchange rate. Compared with the verbal predictions of Japan, South Korea, and Thailand, the Indonesian central bank directly stepped down and restrained the decline of the local currency by selling high-yield securities and buying Indonesian rupiah.

Goldman Sachs concluded that central banks in different types of economies may adopt different response strategies. Central banks in export-oriented economies may be more tolerant of a weaker local currency, while central banks in economies with higher current account deficits, inflation, and external debt may be more proactive in taking measures to stabilize their currencies:

We believe that Indonesia's central bank is even willing to further raise interest rates to maintain the stability of the Indonesian rupiah. The Philippine central bank has expressed its determination to curb currency depreciation by continuously raising interest rates in 2022.

Goldman Sachs expects that if the dollar rises further, the dollar against the Korean won will move closer to the high of 1,441 in October 2022, and the dollar against the Thai baht will move closer to the high of 38.37 in September 2022. It is worth noting that USD/INR and USD/MYR are very close to their previous all-time highs, and these currencies are expected to weaken further in the future.