Singapore: The US Federal Reserve’s new policy of flooding US markets with cash may play well into the hands of Asian policymakers if it weakens the dollar, allowing them to cut rates faster and shift focus to limiting currency gains.
Asian central banks will continue easing monetary conditions to soften the impact of a deepening global recession, analysts said, and the Fed’s pushing rates to zero will definitely hasten that process.
But in a region whose lifeline is exports, a more critical concern will be the weakness in the US dollar that the Fed policy engenders, and the impact of a possible recovery of its currencies on exporters’ profits.
Currency issues: The US Federal Reserve in Washington, DC. The Fed took its target overnight policy rate to a record low zero to 0.25%. Karen Bleier / AFP
It means central banks that have hitherto sold dollars to defend their weak currencies would now be trying to keep them from strengthening too much, thereby buying dollars and pumping in local currency that their markets badly need.
“We could see central banks coming back into the market and buying dollars because, given the growth and inflation outlook in the region, the last thing the policymakers want is a stronger currency,” said Peter Redward, head of Asian research at Barclays Capital.
The Fed took its target overnight policy rate to a record low zero to 0.25% on Tuesday and promised to buy more debt and expand its balance sheet.
The dollar extended a two-week downtrend, hitting two-month lows against the euro and a nearly 13-year low against the yen. In Asia, the Philippine peso hit a two-month high and the Indonesian rupiah gained 2%.
The dollar’s retreat has provided some reprieve for currencies such as the rupiah and Korean won, which hit their lowest levels in a decade in October and November this year.
Yet, that dollar weakness is not welcome in a region where exports can account for 200% of economic output—at a time when local demand is slowing and markets in Japan, Europe and the US are in recession.
“What’s most important now as far as regional markets are concerned is that they limit the appreciation bias against the dollar,” said Dwyfor Evans, a strategist at State Street. “If you are in a scenario where the rest of the world is slowing down, and your currencies are beginning to appreciate as well against the one of your major export market, that’s a bit of a recipe for disaster. Not only are you putting your corporates at relative disadvantage, but the end user export markets just aren’t there.”
If Asian policymakers manage to keep their currencies from strengthening so far as to hurt export pricing, the region’s new monetary policy mix, owing to the turnaround in currencies, could actually prove to be easier to manage.
Weakening currencies against a backdrop of falling inflation also played into the policy easing bias, until that point when some tumbling currencies threatened to plunge economies into crisis and required central banks to sell dollars. Governments in South Korea, India and elsewhere in Asia were both selling dollars to support their currencies and injecting huge amounts of funds in money market operations to replenish the local cash that was being sucked out by the intervention.
The wildcard in this senario is the dollar. No one is quite sure if it will keep weakening, particularly as the Fed’s move forces the hand of central banks in Europe and Japan to adopt similar drastic monetary easing.