Asian currencies appear attractive against the dollar, given its relative valuations, slower rate cut expectations, positive trade and growth differentials.
In brief
- The U.S. dollar has seen a more muted decline against Asian currencies than against developed market currencies, with an Asia trade-weighted index showing only a 1% drop since its 2022 peak.
- The depth of interest rate cuts in Asia is expected to be shallower than in the U.S., narrowing interest rate differentials against the dollar.
- Resilient economic growth, fueled by strong tech-led export activities, means higher demand for Asian goods, a tailwind on Asian currencies.
- Opportunities to capitalize on the dollar’s depreciation against Asian currencies exists in both equities, on improving earnings outlook, and fixed income on attractive real yields.
Dollar strength through an Asian lens
The U.S. dollar has experienced a notable decline from its 2022 peak when measured by the Dollar Index (DXY) and a decline of 3% from its most recent peak in April this year. However, the U.S. dollar’s fall was more muted from Asia’s perspective since the same April peak, with a milder depreciation against the Chinese yuan, the Korean won and the Taiwanese dollar, and even appreciated against the Indian rupee. To better assess the dollar’s position relative to Asian markets, we constructed an Asia trade-weighted dollar index (Exhibit 1), which measures the dollar’s strength relative to a basket of Asian currencies. The index1 includes China, India, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand, with weights derived from total trade turnover with the U.S.
Exhibit 1: Muted USD depreciation vs Asian currencies
Relative index level, Dec 2019 = 100
The dollar’s multifaceted legs in Asia
Historically, this Asia trade-weighted dollar index has moved largely in line with the DXY but with lower volatility. However, a disconnect emerged in 2023 and the spread between the two currencies indices has continued to widen.
On the dollar side, the recent decline was a result of falling inflation rates, which led to the start of the U.S. Federal Reserve’s (Fed’s) rate-cutting cycle in September. While this is evident from the DXY falling 8% from its 2022 peak, the Asia trade-weighted index, comparatively, is only 1% lower today, with the dollar still trading stronger against currencies such as the Japanese yen, the Indian rupees and the Taiwanese dollar.
Even comparing to pre-covid levels, the Asia trade-weighted index still stands 11% higher, more than the conventional DXY’s 7%. Compositionally, the dollar trades has stayed elevated against almost all Asian currencies, including the Japanese yen (+38%), the Indian rupee (+18%), the Korean won (+17%), and the Taiwanese dollar (+7%).
The shorter-term factors at play
Many factors can influence currency direction, not limited to expected growth differentials, trade balances, inflation expectations, capital flows, and interest rate differentials.
On interest rates, although an easing bias should broaden out across Asia, domestic conditions will likely dictate the pace and timing of rate cuts, as we noted in a previous piece.
Compared to the U.S. where markets are pricing in close to four rate cuts (92bps of easing) in the next six months, the depth of interest rate cuts is expected to be shallower for Asian central banks (China: -35bps, India: -34bps, Korea: -33bps), with some markets priced for a tighter monetary policy (Japan: 20bps, Taiwan: 7bps) (Exhibit 2). This implies that Asia should gain ground on interest rate differentials against the dollar from current levels, allowing for Asian currencies to appreciate further.
Exhibit 2: Shallower interest rate cuts expected in Asia
Current policy rates vs 6-month forward market implied rates (bps)
Additionally, amidst a global growth slowdown, broad Asia ex-China has seen relatively more resilient economic growth, in part fueled by strong tech-led export activities. With technology goods continuing to be a key global manufacturing sector, Asia starkly contrasts with the U.S.’s longstanding trade deficit. Net demand for Asian goods thus becomes a tailwind for Asian currencies. Lower inflation rates in Asia, with most regions nearing their central banks' targets, should also lead to more attractive real yields. This should draw foreign capital flows into domestic financial markets, supportive of domestic currencies.
A key risk will be any potential changes to trade policies arising from the upcoming U.S. presidential election. An increase in tariffs on all imported goods into the U.S. would mean less demand for goods from Asia, a headwind for Asian currencies.
The journey from here
Our base case for the U.S. remains a soft-landing outlook, and the Fed will likely be taking its time in cutting rates back to normal. When contrast to the Eurozone’s and the U.K.’s steadily falling inflation rates and low growth outlook, the European Central Bank and Bank of England could well cut more over than the Fed in the quarters ahead, suggesting that the DXY may move sideways rather than down.
However, with the relatively muted depreciation against Asian currencies, the dollar’s direction could be different in Asia. The region’s relatively stronger economic prospect means Asian central banks are in no rush to ease monetary policies. Additionally, idiosyncratic concerns such as volatile food prices in India, elevated housing prices in Taiwan and Korea means that risks are skewed towards a later start to interest rate cuts or fewer rate cuts in the coming months than in the U.S. Thus, unlike the DXY, the dollar could see further depreciation compared to Asian currencies.
Investment implications
As global central banks continue to loosen monetary policies, the relative size of rate cuts will likely be a deciding factor on currency movements in the coming months. Asian currencies appear attractive against the dollar, given its relative valuations, slower rate cut expectations, positive trade and growth differentials.
In our view, priority should always be given to maintain a sufficient amount of domestic currency for day-to-day cash flow needs and operations, while the dollar’s safe heaven characteristic also makes it an apparent choice over other currencies as a defensive allocation against risk-off environments in portfolios. Thus, we think an exposure through other related asset classes on an unhedged basis more opportunistic for investors seeking to capitalize on the dollar’s depreciation against Asian currencies.
For the Asian equities, we note that companies with a higher portion of revenue derived domestically tend to be leaders in earnings growth. A stronger domestic currency is therefore a tailwind for these companies on lower import costs. Export-orientated companies, on the other hand, should see limited adjustment as global growth cools under a soft-landing scenario, and offset by currency appreciation on total return basis. On an aggregate, historical performance has also shown the asset class exhibiting a strong relationship of outperformance against developed market equities when the dollar weakens.
As for fixed income, Asia’s lower inflation rates have presented investors with opportunities of attractive real yields, most notably in Indonesian bonds. A stronger interest rate differentials in Asia against the dollar should also see higher capital flows into interest-bearing domestic instruments, hence marking emerging market debt another feasible option, especially for those seeking an income generation allocation.
By diversifying into the various relevant asset classes, investors could gain access to the wide opportunity set as Asian currencies appreciate, while also spreading their risk premiums and keeping a resilient defensive allocation, thus allowing for a well-rounded portfolio construction.