In brief

• The U.S. dollar has been boosted by interest rate differentials and risk aversion. It is likely to remain strong in the near term.
• Asian currencies have depreciated in response, but local factors are leading to difference in performance.
• Despite more potential weakness in Asian currencies in the near term, asset and currency valuations are looking increasingly attractive to long term investors. Growth factor performance year-to-date.

A strong U.S. dollar boosted by rates and risk aversion

The U.S. dollar (USD) has rallied almost 15% year-to-date to a 20-year high. In Asia, all currencies depreciated, but the magnitude of this depreciation has been particularly severe for the Japanese yen (JPY), which has weakened by 20% against the USD since the start of 2022. The Chinese yuan (RMB) has dropped by 8% against the greenback year-to-date and a relatively sharp drop by its own historical standard.

A strong USD is a double-edged sword for everyone. It helps the U.S. economy to make imports cheaper and relief some inflation pressure, but it hurts U.S. companies’ overseas earnings when translated back into USD. For other economies around the world, a weak currency helps to boost export competitiveness but makes imported good, including food and energy, more expensive and exacerbate local inflation. Moreover, a strong USD traditionally triggered capital outflow from emerging economies and create financial instability, forcing local central banks to hike rates aggressively.

A more stable (and preferably weaker U.S. dollar) would be welcomed by investors – but when will the U.S. dollar peak? Looking at the factors driving USD strength, there have been two main phases of U.S. dollar strength this year:

1. March and April when the U.S. dollar rallied 6.4%. This move can be explained by widening interest rate differentials between U.S. Treasuries and other developed market government bonds. The Federal Reserve was on a more hawkish hiking path than other major central banks.
2. Then in the summer (June, July and August), the USD rallied 6.7%. This move was less driven by interest rate differentials, which were unchanged during that time period. Expectations for rate hikes by the BoE and ECB moved up in tandem with the Fed. Instead, USD strength was driven by global growth fears taking the front seat, especially as concerns about the energy crisis in Europe and “zero COVID” in China intensified, fueling capital flows back to the safety of U.S. assets.

In the short-term, the U.S. dollar peak may be delayed as investors continue to wrestle with global recession fears, keeping volatility elevated across assets. However, investor sentiment about global growth over the next few quarters has already gotten so depressed that “less bad” news can fuel a turnaround in foreign currencies.

Asian currencies are going with the flow

Asian currencies have depreciated against the USD. The Japanese yen’s weakness (-20% vs USD year-to-date) is brought by the Bank of Japan’s insistence that demand-led inflation is not well anchored and hence it needs to maintain its ultra-loose monetary policy. This contrasts sharply with other developed market central banks which are aggressively tightening. While it has intervened in the currency market on September 22 to curb JPY’s fall, this likely helps to slow down the depreciation instead of marking a reversal in the currency’s downward trend.

The Chinese yuan weakened past 7 yuan to one USD (-8% vs USD year-to-date) for the first time since July 2020. This reflects the broad USD strength since the CNY’s exchange rate against a basket of currencies remains largely stable. We have also seen the Chinese authorities introducing measures, such as cutting foreign exchange (FX) reserve ratio and increase risk reserve ratio for FX forward trading, to stabilize its currency.

For the rest of Asia, the weakness of the Taiwan dollar (-11%) and Korean won (-13%) mirrors the weakness of their equity markets and the upcoming challenge of softer exports demand. Indonesia (-4%) and India (-6%) have been surprisingly resilient. Indonesia (and other commodity exporters) benefitted from high commodity prices boosting their current account surplus, as well as keeping local prices stable with domestic supply of food and/or energy. For India, improved current account balance and proactive central bank in raising interest rates to address in inflation have supported its currency. It should also be noted that most Asian economies still maintain a positive real rate differential vs. the USD. That should continue to provide some level of support to their currencies. 

Exhibit 1: Currency deviation from 10-year average in real effective exchange rate* terms

Number of standard deviations away from average

Source: FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. *The real trade-weighted exchange rate index is the weighted average of a market’s currency relative to a basket of other major currencies adjusted for the effects of inflation. The weights are determined by comparing the relative trade balances, in terms of one market’s currency, with other markets within the basket. Past performance is not a reliable indicator of current and future results. Data reflect most recently available as of 26/09/22.

Investment implications

Growth uncertainties and resulting risk aversion is likely to keep the USD strong in the near term. This is reinforced by the Federal Reserve’s hawkish tone in the September meeting. This could imply room for moderate depreciation in both major and Asian currencies. Yet, we think the risk of a currency crisis in major Asian economies is still low at this point, considering their current account surpluses and ample foreign exchange reserves. If support is needed, currency swap lines can also be established.

For long term investors, both asset valuation and currency valuation (see Exhibit 1) are looking increasingly attractive. Admittedly, the global growth outlook is challenging for Asian exporters in coming quarters. However, domestic recovery as Asian economies gradually reopen should provide some positive offsets to earnings challenges.

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