Dollar strength may prompt more Asia rate hikes to boost currencies

As long as the greenback is the reserve currency par excellence, Asia will fret about the dollar's strength or weakness. (Source: Bloomberg)

Goodbye helping hand, hello shock therapy. Central banks in Asia are entertaining muscular tactics to shore up faltering currencies. That means dispensing with carefully crafted words designed to convey attentiveness without locking officials into drastic steps that might well punish bears — and the economy. Something more arresting is required.

With the dollar’s persistent strength sweeping away predictions of a good year-end for emerging-markets, the greater risk is that governments under-react. Letting currencies weaken too much can jeopardise financial stability and fuel inflation. Indonesia got the message.

The point of the country’s startling interest-rate increase last week may have been that it happened at all. One hike won't tip Southeast Asia's biggest economy into recession. Nor, unfortunately for Jakarta, will it produce a sustained rally in the rupiah. Authorities waded into the market Monday to slow the currency’s depreciation as it approached 16,000 per greenback, the lowest level since early 2020. The rupiah is down 3 percent this month, by far the worst performer in Asia.

As a signal that authorities are squarely focused on braking the currency's slide, however, the rate increase is powerful. Bank Indonesia Governor Perry Warjiyo gave every impression earlier this month that he was firmly in the extended pause camp. The implication of this upset is that if FX weakness persists, further tightening is in the cards. Defense of the rupiah has supplanted managing domestic prices and growth as the priority.

Asia’s challenges are acutely illustrated in Indonesia, though not unique to the archipelago. How long will Malaysia, where rate hikes were suspended in April, stand by and watch the ringgit retreat to levels not seen since 1998? On Thursday, the Philippines lifted its main rate in an off-cycle decision and said it was prepared for “follow-through” supplementary moves. The Bank of Korea, once seen as a candidate for cuts in borrowing costs this year, sounded more — not less — hawkish last week. The differences are more of degree, rather than kind.

Nor is anxiety limited to Asia’s emerging markets: Investors would be prudent to brace for another surprise from Bank of Japan Governor Kazuo Ueda. The Nikkei newspaper reported on Sunday that the BOJ is contemplating an additional tweak to its policy of containing yields on long-term government bonds. The threat of intervention from the Ministry of Finance also hangs over markets; the yen briefly retreated to less than 150 per dollar on Monday.

This was always going to be a harder year to get the interest-rate trajectory right. In 2022, the action was all about reining in inflation, with rates starting at very low levels. The only way to go was up, up, up. What followed was going to be trickier: identifying the level at which to hold borrowing costs. Inflation is coming down in most economies, but not yet to where a cut could be justified. For countries without reserve currencies this is dangerous territory. Forward guidance, the art of conveying your intentions well in advance so as not to roil markets, a tool that was extremely handy during a more benign era, is very challenged.

Enter Warjiyo’s bombshell last week. Not only was the hike predicted by just one of the 31 economists surveyed by Bloomberg, it's contrary to what Warjiyo conveyed on Oct. 6 when he told Bloomberg Television that “we will have to hold our rate for a while.” That sounds pretty categoric, even though central bankers are loath to hear projections characterized as promises. He must have become very worried about the rupiah to enact such an about-face, especially when he conceded in the same interview that domestic conditions might be more consistent with a cut.

When Bank Indonesia began communicating more in 2018, Warjiyo praised the value of words. It's not just about public relations, he told reporters in March of that year. Perhaps forward guidance has already lived its best days. History may determine such direction was a creature of the low-inflation world that followed the global financial crisis of 2007-2009 — unless officials’ purpose is to do something else entirely. In that sense, the disturbance will help convey the message: Things are so bad, we are doing the opposite of what we told you.

It's one thing to blame poor official communications. For their part, investors should never outsource their views entirely to central banks. While it’s rarely in the long-term interests of policymakers to blindside the market too often, traders probably became addicted to hand-holding over the past decade and a half. They need to make their own assessments. If they have forgotten, they ought to learn again in a hurry.

When it comes to currencies, decision making can be fluid. Bank Indonesia made it clear the hike was intended to steady the rupiah. “The global dynamic is very fast,” Warjiyo said on an investor call after the hike. “We need to review again from month to month. Our goal is the same: Price stability, financial system stability and payment system stability to support our economic growth.”

It's unfortunate that some central banks in Asia hit the pause button early in the year.  It was very risky to step back from rapid hikes while the Federal Reserve was nowhere close to being done with tightening. Also prevalent was the misguided — notion that policy in Asia had decoupled from the Fed. As long as the greenback is the reserve currency par excellence, Asia will fret about the dollar's strength or weakness.

China’s economic footprint in the region may well be growing; it’s the largest trading partner of many nations. But when it comes to currencies, there is still just one superpower. Bristle or rail at the dollar as often as you like, ultimately the hegemon prevails.

Daniel Moss is a Bloomberg Opinion columnist. Views do not represent the stand of this publication. 

Credit: Bloomberg