After a bruising few years, Asian currencies have suddenly become fashionable again. But this enthusiasm is dependent on words and deeds far away. The direction of global markets is driven overwhelmingly by the US. For now, that means interest-rate cuts by the Federal Reserve. Long depicted as Asia’s engine, China’s economic outlook is deteriorating, even as its currency is lifted by the tide generated in Washington. It would be imprudent to get too excited about Asia’s FX prospects without understanding the roots of the newfound positivity.
The prospect of easing by the Fed, the most powerful central bank and guardian of the dollar, has pushed the greenback down — and counterparts up. The yen’s rally, given an added boost from a recent surprise rate hike, has attracted the most attention. That seems only fair, given how beaten up Japan's exchange rate had been. The Thai baht and Indonesia’s rupiah have notched notable appreciations. Even the ringgit, whose lack of fans had frustrated officials in Kuala Lumpur, is having a strong run. Further afield, the Swiss franc and British pound are viewed more positively. But there may be an even more compelling story: the yuan.
Gains by China’s currency have been such a relief for Beijing that the central bank has backed away from an important measure of support. The yuan has erased much of the year's losses versus the buck, and has strengthened toward the psychologically important level of 7 per dollar. So noteworthy has the shift been that the FX regulator has gone from striving to put a floor under the yuan to worrying about whether it will rise too far, too quickly. Official meddling in exchange rates is nothing new or unique to China. Tokyo intervened several times this year to stem the yen's decline, and for decades sought to curtail the opposite problem, that of its strength.
China has exerted influence on a more granular basis. While the government ended a hard peg to the dollar in 2005, and gradually allowed greater daily moves, the People's Bank of China has kept it on a fairly tight leash. One of the main ways that officials can signal their desires is the so-called daily fixing. Fluctuations around that point are constrained. For the past year, the fix has focused on limiting losses, though stopping short of preventing them all together. Dollar sales by state-backed banks were another prop. Late last month, things changed: The PBOC began setting its daily fix broadly in line with market expectations, according to Bloomberg News. A reasonable interpretation is that administrators are more comfortable about where investors want to take the currency. With several rate cuts by the Fed penciled in this year, its understandable traders are inclined to favor the yuan.
What's more noteworthy is that this boomlet is happening as China's economic prospects turn more bearish. Factory activity contracted for a fourth month in August, according to data released on Saturday. The woes of the residential property market were underscored a few hours earlier when China Vanke Co., a large developer, reported a half-year loss for the first time in decades. UBS Group AG recently trimmed its estimate for growth this year to 4.6%, down from an earlier prediction of 4.9%.
These numbers suggest waning confidence that the government will meet its target of an expansion in gross domestic product of around 5% this year. Perhaps China should consider scrapping such numerical targets; they create a sometimes unrealistic benchmark by which the economy is measured. No doubt, China is enduring a difficult stretch.
Is it too simplistic to pin the yuan's modest recovery, and the broader regional rebound, on the Fed? Most commentary points to Chair Jerome Powell's speech at Jackson Hole late last month when he said the time for rate cuts has arrived. (One prominent yen bull, Macquarie Group Ltd., said the Japanese currency’s rally was due almost entirely to Jackson Hole.) Another Fed event may not have been given sufficient attention: On July 31, at the conclusion of the Federal Open Market Committee's meeting, the central bank's statement — and Powell, at his press conference — left little doubt cuts were approaching. This was, arguably, the true pivot.
China has long sought to simultaneously contain yuan bears and promote use of the yuan as a global currency. How ironic that all it takes a few words from the US central bank to achieve the former. It shows how far China is from being successful in its campaign to erode dollar hegemony in any meaningful way. For now, it's Planet Fed. Talk about frenemies.
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