Not all doom for South-East Asia’s cratering currencies

ASEAN currencies may be hammered by the almighty US dollar, but regional central banks are poised to withstand the Fed’s test, said Edward Lee.

May 15, 2024

5 mins

Corporate & investment banking

Originally published in The Business Times

Markets across South-east Asia haven’t had much to cheer about lately, as regional currencies are sagging against the greenback amid a revival of the higher-for-longer narrative on US interest rates. 

But though there’s no case for merrymaking, there’s none for pessimism too. 

In the short-term, the Fed’s decisions may be the key factor driving the dollar against regional currencies, but “from a medium- to longer-term perspective, have a look at the robustness of the economies in our region”, said Edward Lee, Standard Chartered Bank’s chief economist and head of foreign exchange for ASEAN and South Asia.

“The huge amount of foreign direct investment (FDI) that continues to come to our region is a strong statement about the attractiveness of ASEAN,” he noted. “FDI continues to love our region.” 

As the greenback charts its upward course, regional currencies are bearing the brunt of it. 

The US dollar index – which measures its value against a basket of six major currencies – has climbed about 4.2 per cent between January and May.

Conversely, all ASEAN currencies, except the Cambodian riel recorded a year-to-date depreciation against the US dollar of between 0 and 8 per cent.

The Japanese yen sank about 9.6 per cent, the Taiwan dollar fell roughly 6 per cent and the Korean won slipped around 5.2 per cent. 

The Bloomberg Asia Dollar Index, which tracks the performance of a basket of Asian currencies against the greenback, has dipped roughly 2.8 per cent since the year began. 

Recall that at the start of the year, interest rate markets were pricing in about 175 basis points of rate cuts by the Fed this year, but have now pulled back to only about 35 basis points, said Lee. 

This, he believes, is the no 1 factor driving the US dollar against regional currencies.

Other factors include the macro narrative for China, which has been muted in the past few months. This has “inevitably also held back sentiment for this part of the world”, as well as geopolitical tensions, which are driving oil prices up. 

But, at the end of the day, it is important to compare a currency with those of the country’s key trading partners too, and not just against the greenback, said Lee. “Everybody is losing against the US dollar.”

The way he sees it, there is no cause for alarm, as the region’s foreign exchange weakness does not stem from internal factors. 

South-east Asian economies have come a long way since the late-90s, when the Asian financial crisis hit, and have built up their financial capabilities to better withstand currency volatility and shocks. 

“We’ve all learned our lesson,” Lee said. “Our domestic capital markets are all better built… financial systems in the region are so much more robust and developed. Looking at the traditional vulnerabilities previously, we are now much better positioned than before.” 

In fact, the chief economist believes central banks should take caution not to draw a line in the sand.

Even if a nation’s monetary authority pledges not to let its exchange rate reach a certain level against the greenback, there exists a genuine demand from businesses for the US dollar. Because the central bank has publicly committed to maintaining a specific threshold, it will have to keep providing US dollars. 

And when the reserves dry up, along with it goes the bank’s ability to manage any currency volatility, Lee said. 

For ASEAN currencies to catch some serious respite, the US dollar has to dial back on the heat, which means the Fed first has to cut interest rates. 

At its most recent meeting on May 1, the Fed held steady its federal funds rate at a two-decade high of 5.25 per cent to 5.5 per cent. 

“While (Fed chairman Jerome) Powell avoided answering whether rate hikes were discussed during the meeting, he pushed back firmly against the idea that rates may need to be raised,” Lee noted. 

“This is important as it lowered the tail risk of expectations moving even more towards a rate hike, which would have been negative for ASEAN currencies.”

The house projects two rate cuts of 25 basis points each in end-July and December. 

Even so, US interest rates will still be high, said Lee. “From what I can see at the moment, if you actually gain, say, 2 per cent to 3 per cent against the US dollar this year, you will be considered one of the outperformers in the regional complex.”

Lee reiterated that central banks in the region are a lot more attuned to financial markets nowadays. 

“At the end of the day, in the medium- to longer-term, it’s all about more structural stuff – whether the economy is growing, whether it’s attracting FDI, whether inflation is well-managed and the robustness of the economy,” he said. 

“In the short term, central banks can largely lean against the wind.”

Source: The Business Times © Singapore Press Holdings Limited. Permission required for reproduction.