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Goldman Sachs expects the dollar to rise 5% this year, which could be terrible news for Asia.
Past episodes of extreme dollar strength have not gone well for this most dynamic economic region. The most obvious example is the Asian financial crisis of 1997-1998.
This calculation stems from the Federal Reserve's 1994-1995 tightening cycle. At that time, the Federal Reserve doubled short-term interest rates in just 12 months. The resulting appreciation of the U.S. dollar made it unsustainable for Asian currencies to peg themselves to the U.S. dollar. The first was Thailand's devaluation in July 1997. Then there is South Korea.
Other events include the 2013 Fed “taper tantrum.” The turmoil prompted Morgan Stanley to publish a list of “Fragile Five” countries, on which no emerging economy wants to be included. Original group: Brazil, India, Indonesia, South Africa, Türkiye.
Now, a surge in the dollar is complicating Asia's development plans again. The greatest magnet in history is attracting capital from every corner of the globe, gobbling up the wealth needed to finance budget deficits, keep bond yields stable, and support stock markets.
As Donald Trump prepares to return to the White House, the yuan and yen depreciate. Trump won't be happy to learn that Asia's two largest currencies are sinking against a strong dollar.
Yet this dynamic serves no one. Or as economists such as SPI Asset Management's Stephen Innes put it, “dollar dominance” will become an “economic wrecking ball” for an already marginalized Asian region.
Currency trends may reinforce Trump's desire to gain U.S. trade advantages through a weaker dollar, or to attempt Plaza Accord-like measures to change currency trends.
A stronger dollar may increase Trump's desire to push the Fed to do its dirty work. If Fed Chairman Jerome Powell thinks his team can ignore Trump's demands to lower interest rates this year, he's dreaming. Powell's ouster in the Trump 1.0 era added liquidity to an economy that didn't need it. As Trump 2.0 seizes control of finance, he will likely be in power again.
Goldman Sachs isn't the only firm forecasting a further 5% appreciation in the dollar this year. Data from the Commodity Futures Trading Commission found that investors from large asset managers to hedge funds are the most optimistic about a rising dollar since 2019.
This was despite the fact that Trump and Chinese leader Xi Jinping ended up getting along well on January 20. Or whether Trump will follow through on his threatened 60% tariffs.
Such predictions come despite the fiscal realities Trump will face. As much as Trump likes to talk about President Joe Biden's spending, he added about $8 trillion between 2017 and 2021 to the national debt, which now exceeds $36 trillion.
Currently, only one top rating company rates Washington as AAA. If Trump pushes for new tax cuts, Moody's Investors Service could quickly roll back the last one. Or if U.S. lawmakers toyed with raising the debt ceiling or shutting down the government.
At the same time, Trump's intervention in the Fed may go too far. One of the reasons for the accelerated rise in the dollar is the change in expectations for a rate cut by the Federal Reserve. Just two months ago, Powell's team appeared to be firing on all cylinders on lowering U.S. borrowing costs. A series of strong data reports since then have led the Federal Reserve to delay easing measures.
Meanwhile, Federal Reserve Governor Michelle Bowman said in a speech on January 9 that inflation remains “disturbingly above” the Fed's 2% target. “I support the December policy action because, in my view, it represents the final step in the FOMC's policy recalibration phase,” Bowman said. She added that the Fed's benchmark is currently between 4.25% and 4.5%, representing “neutral” territory.
Changes in the Federal Reserve's expectations have led the Bank of Japan to continue to make adjustments. Just as the Fed asked economists to get back to planning, BOJ watchers were caught off guard by Tokyo's shift in priorities.
On December 19, global markets were fully prepared for the Bank of Japan to raise interest rates. Governor Ueda stood aside and watched. Part of the reason is concerns about global market jitters. Ueda's policy committee may be concerned that the Bank of Japan's tightening policy and the Fed's failure to increase liquidity could hit stock and currency markets everywhere.
U.S. interest rates have remained elevated for longer than expected in Asia, complicating matters at the People's Bank of China headquarters. As the U.S. dollar gains ground, the yuan faces strong downward pressure.
Since China is suffering from deflation, there are good reasons to welcome a weaker exchange rate. Yet risks remain. A weaker yuan makes it harder to repay offshore debt, increasing default risks for property developers. Currency manipulation will hinder efforts to internationalize the RMB. In addition, this will also anger Trump World and intensify the scale of future trade wars.
However, a runaway dollar may be the last thing Asia needs. As the wrecking ball swings again, policymakers in the region had better be prepared.
