While a rate cut by the US Federal Reserve later this year may not be good news for the dollar, certain Asian currencies could profit.

A nation’s currency gains value when interest rates rise, drawing in foreign capital and boosting demand for the national currency. In general, emerging markets benefit from a weaker US currency, which is frequently the case when the Fed lowers interest rates outside of an economic crisis.

Since the Fed adopted a more dovish posture in December, rate reduction by summer are now priced in by the markets. The first 25 basis point rate decrease in 2024 might take place as early as June, according to the CME FedWatch tool.

Following its January meeting, the Fed decided to maintain its benchmark borrowing rate in the range of 5.5% to 5.25%.

Experts predicted that the Fed’s relaxation of monetary policy would help currencies like the Indian rupee, the Korean won, and the Chinese yuan.

Yuan can’t sink any lower

China has endured a barrage of depressing news stories that have undermined investor confidence. However, yuan pessimism has been curbed by hopes that the government would not permit the trade-dependent country’s currency to drop below a specific threshold.
Arun Bharath, chief investment officer at Bel Air Investment Advisors, says China is likely to carry on with its past attempts to stabilise the yuan versus the dollar.

“While the exchange rate has weakened to a 7 handle on the USD/CNY rate, reflecting a weaker economic situation in China, further weakening is unlikely as policymakers start to be more aggressive in fiscal stimulus, credit growth, and propping up property values,” Bharath said.

The exchange rate of the Chinese yuan will probably stay in “a narrow band around the current exchange rate of 7.10,” he predicted.

China maintains stringent control over the onshore yuan, in contrast to other major currencies like the US dollar and the Japanese yen, which have freely fluctuating exchange rates. The currency is fixed to the US dollar using a mechanism known as the “daily midpoint fix,” which is based on quotes from interbank dealers and the yuan’s previous closing level.

The onshore yuan fell to a 16-year low of 7.2981 against the US dollar last year.

The yield differences between the two biggest economies in the world would probably close by the summer if the Fed begins reducing rates, which would also take some of the pressure off the Chinese yuan.

Bonds can be compared using yield differentials, which show variations in yield.

The People’s Bank of China is a major player in currency management, which it can accomplish through regulatory channels, daily fixing, liquidity controls, and ordering state banks to step in, according to Simon Harvey, head of FX analysis at Monex.

Since it is uncertain how much money is in China’s foreign exchange reserves overall, the last technique is the most opaque.

Rupee rising

Carry trades, in which traders borrow low-yielding currencies like the US dollar to purchase high-yielding assets like bonds, may be advantageous for the Indian rupee this year.

“A lot of carry trade against other currencies like the yen or the euro but once interest rates fall in the U.S., we will see the interest rate differential widen to allow carry trade to happen. So those are also positive for the Indian currency,” said Anindya Banerjee, vice president of currency and derivatives research at Kotak Securities.

In anticipation that the Reserve Bank of India may relax monetary policy more gradually than other central banks, the rupee may also appreciate.

The RBI would “always significantly lag the Fed” in rate cuts, according to Banerjee, because “India did not have the same inflation problem which Europe or America had.” The rate cut speed will be “far slower” than the Fed.

“The reason is simple, because fiscal policy is firing on all cylinders, the economy’s doing very well and they don’t want any overheating at this point in time,” Banerjee said.

In the past three months, the rupee has appreciated to a level of 82.82 against the US dollar. In 2023, the currency fell by 0.6% versus the US dollar, a far lesser amount than the 11% drop in the previous year.

Take the pressure off Korea’s victory

After three years of pressure, the won will see some relief in 2024 thanks to better economic outlooks and more lenient Fed policies.

“As a low yielding and highly cyclical currency, we think the Korean won stands to be one of the major beneficiaries of the Fed’s easing cycle in the second half of the year as lower U.S. rates will not only reduce pressure on KRW through the rates channel but will also lead to an uptick in the global growth outlook,” Monex’s Harvey said.

However, Harvey stated that the size of the Fed’s cutbacks will also affect the winners’ earnings. If the easing cycle is deep, the currency may rise as much as 10%, he projected, or as little as 3% if it turns out to be shallow.

The economic outlook for South Korea is also anticipated to improve this year. In contrast to the 1.4% growth of the previous year, the International Monetary Fund forecast 2.3% growth in 2024 and 2025.

(Adapted from CNBC.com)

Categories: Economy & Finance, Geopolitics, Strategy