Will a strong dollar hurt emerging markets again?
THE US dollar continues to strengthen despite the U-turn in the tone of the currently dovish Federal Reserve.
Will this derail the rebound in emerging markets (EMs) which were battered last year as the Fed raised interest rates aggressively?
Said to be red hot now, EM action was fuelled by expectations of further dollar weakness, which has not happened since the Fed signalled a pause in rate hikes two weeks ago.
The dollar has, surprisingly, risen by 1.5% since the Fed meeting on Jan 30. Those who, at the beginning of the year, had expected the US currency to fall, have switched to a more upbeat view of the dollar.
As global growth weakens, the US economy is looking relatively stronger than those of other developed countries.
The European Union’s warning that the economy may grow by 1.3% instead of 1.9% this year, further stokes concerns over slowing growth. Car sales in Europe fell for a fifth straight month; passenger car registrations declined 4.6%, year-on-year, with lower sales in all the largest markets.
The sagging fortunes of major eurozone countries like Italy and Germany, which has raised the likelihood of monetary easing, makes the dollar more appealing.
Some believe the dollar could rally further if China’s economy keeps on slowing, and as the country ratchets up its credit creation.
While the dollar has strengthened against major currencies like the euro, pound and yen, it has fallen against a broad range of EM currencies.
Year-to-date returns for the Bloomberg JP Morgan Asia Dollar index is still at 0.45%.
EM currencies are benefiting from a more dovish Fed, prospects for a US-China trade deal and higher commodity prices like oil and palm oil.
However, they may become riskier on further concerns over global growth and little progress achieved in the US-China trade talks.
A strong dollar will encourage capital outflows from EMs, thereby weakening their currencies.
A factor to watch is yuan weakening, as this could weaken the ringgit which is in a quasi peg to the yuan, said Inter-Pacific Securities head of research Pong Teng Siew.
However, dollar strength may not persist as the US economy is slowing. US retail sales registered the biggest drop since 2009, while industrial production fell 0.6% in January, the first drop in eight months, against a forecast for a gain of 0.3%.
Together with the Fed’s dovish stance, this may signal the peaking of the dollar.
“Markets expect a change in US rate hike policy and some even project a US rate cut next year,’’ said Areca Capital CEO Danny Wong.
The first Fed rate cut may be the cue towards the next recession which could mark the beginning of a nasty bear in the US, said Pong.
The recent surprise cut by the Reserve Bank of India (RBI) of 0.25% in its key lending rate, following a sharp fall in inflation, may set the stage for similar moves by major central banks.
The Bank of Japan kept rates steady but trimmed its inflation outlook, as exports in December shrank at their quickest rate in two years.
Reserve Bank of Australia governor Philip Lowe said its cash rate that the central bank charges commercial banks on overnight loans, could be cut further if income and spending weaken.
Despite expectations for a rate hike in New Zealand, ANZ economists forecast a rate cut, starting in November, amid slowing global growth and new capital rules for banks.
Bank of England may cut rates in the event of a no-deal Brexit.
The Fed’s pause in rate hikes provides space for central banks that had raised rates earlier, to lower them to support their economies, said Socio Economic Research Centre executive director Lee Heng Guie.
This is especially in the case of deterioration in global growth, should the US-China trade talks turn sour and lead to a re-escalation of the trade war.
Monetary policy may remain status quo in Malaysia, Singapore and the Philippines, with modest hikes of 50 basis points (bps) in Indonesia (175 bps in 2018), and 25 bps in Thailand (25 bps in 2018), said Maybank Investment Bank group chief economist Suhaimi Ilias.
Bank Indonesia’s next policy decision is on Thursday; it has said its benchmark rate is close to peak.
Thailand held its benchmark rate at 1.75%, as inflation in January rose at the slowest pace in 18 months; some expect an extended pause in rate hikes.
Should dollar strength persist in the long term, EMs would not be able to cut rates as they would have to defend their own currencies, cautioned Hong Leong Bank chief operating officer, global markets, Hor Kwok Wai.