A hawkish surprise from the Federal Reserve is exacerbating declines in emerging-Asia currencies, potentially heralding a longer bout of weakness.
Almost all developing Asian currencies were lower against the greenback after the Fed released forecasts that showed officials anticipate two interest-rate increases by the end of 2023, sooner than many thought. The South Korean won fell as much as 1.5% to pace declines in the region while the Philippine peso, Indonesian rupiah and Thai baht each declined at least 0.5%.
The losses could be the start of a new era of declines in emerging Asian exchange-rates, which have already fallen this month amid speculation the Fed may soon start winding down its bond-buying program. Higher U.S. yields and a stronger dollar are likely to reduce the popularity of carry trades, which had bolstered demand for emerging Asian debt.
“The prospects of a calm carry collection summer seem to be somewhat challenged,” Citigroup Inc. strategists including Gaurav Garg wrote in a note. “Even as Asia is in a better position compared to that last episode of taper chatter in 2013, it is not immune to spillovers from higher U.S. rates and stronger USD.”
The benchmark 10-year yield in the U.S. gained eight basis points on Wednesday in the wake of the Fed decision and is expected to climb even further, analysts say. This will reduce the premiums investors get from buying Asia government debt, reducing their appeal to global funds.
“Despite Powell’s advice to take the dot plot ‘with a big grain of salt’, concerns about inflation are still brought back to the fore,” said Fiona Lim, a senior currency strategist at Malayan Banking Berhad in Singapore. This could “keep the UST yields elevated and weigh on Asian currencies in the near term, particularly those who have benefited from carry trades,” she said.
Even before the Fed decision, emerging currencies had come under pressure with a gauge of implied volatility rising for the first time in two weeks on Monday. Gains in the South African rand — this year’s best performer — have stalled while options traders are adding to bearish wagers on the Russian ruble.
The benchmark MSCI Emerging Markets Currency Index fell 0.6% Thursday, set for the biggest one-day decline in more than three months. But it’s still up 13% from the low reached in March last year. The Bloomberg Dollar Spot Index rose to a two-month high.