Macroscope | Why the yuan, yen and won are vulnerable to US rate rises
Higher US interest rates will make the dollar more attractive, particularly given the less favourable local conditions in Asia
Friday’s strong US jobs data surely sealed the deal for the Federal Reserve to raise interest rates on Wednesday. Tighter US monetary policy may feed into renewed demand for the dollar and in particular versus Asian currencies.
While higher US interest rates might naturally support capital flows into the United States and by definition underpin the external value of the dollar, that process might well go further if local conditions prompt investors to view domestic currencies in a dimmer light than the greenback. China, Japan and South Korea could be cases in point.
The Bank for International Settlements (BIS), launching its latest quarterly review on March 6, said that emerging market economies “have been caught between a rock and a hard place, the rock being the prospect of a tightening of US monetary policy (even if gradual), an appreciating dollar and their FX currency debt, and the hard place the threat of rising protectionism.”
As China seeks to navigate its own safe economic passage, against a backdrop of tighter US monetary policy, it may be that the yuan has to take some of the strain
On China, the BIS noted that “during the quarter, we saw specific tensions in China’s financial markets” with policymakers coming to grips with “the triple challenge of historically high domestic indebtedness, portions of the corporate sector still indebted in foreign currency and the growing internationalisation of the currency.”
It is the BIS’s opinion that while the tensions within China’s financial markets “remained largely contained and did not spread internationally...Such tensions were just the latest reminder of a global economy that is struggling to find a safe passage towards a sustainable, financial stress-free expansion.”
“China will definitely not devalue the yuan to stimulate exports, it will definitely not engage in a currency war,” said Yi Gang, a deputy governor at the People’s Bank of China, on Friday. But that doesn’t exclude the possibility that the renminbi could depreciate versus the dollar.
Already wrestling with the burden of dollar-denominated debt, and now facing higher dollar debt servicing costs due to Fed tightening, parts of China’s corporate sector might well choose to continue to pay down such exposures, a process which could well become evident in further demand for greenbacks versus yuan.