Friday’s announcement by the BLS that unemployment in the US has fallen to its lowest level in half a century further firmed expectations for US interest rates and was sufficient to drive the US dollar to fresh long-term highs against currencies throughout the Asia-Pacific region.
The dollar has rallied and emerging market currencies, together with their proxies, have fallen away this week as Treasury yields have surged to seven-year highs on revised expectations for US interest rates.
Recent adjustments to derivatives prices, which now imply an 80 percent probability of the Federal Reserve hiking a further 25 basis points in December, were seemingly supported on Thursday by Fed Chairman Jerome Powell, who said that US economic expansion could run for “quite some time,” and consequently, US interest rates might need to be raised above “neutral.”
Among those hardest hit by higher US rates and the stronger dollar are emerging markets which, as a whole, borrowed heavily in dollars when interest rates were reduced to record lows in the aftermath of 2007-08’s financial crisis.
In the foreign exchange markets this manifests, of course, as currencies under pressure—currencies such as the Indonesian rupiah, which fell on Friday to a twenty-year low of Rp.15190 to the dollar; the Indian rupee, which fell to an all-time low of ₹74.31; and the Taiwan dollar, which fell to a nineteen-month low of NT$30.94.
Now worth only 70.5 US cents, the Australian dollar—a highly liquid proxy for Asia-Pacific’s emerging market space—is trading at a level not seen since February 2016.
“A simple dynamic is playing out in the global economy right now,” says HSBC’s Kevin Logan; “the US is booming, while most of the rest of the world slows or even stagnates.”
“A Federal Reserve that is raising rates to prevent the US economy from overheating is constraining the policy options of countries where financial conditions are tightening and trade tensions intensifying,” Logan explains.
These constraints are all too real. Consider Friday’s shock decision by the Reserve Bank of India to not raise interest rates as economists had predicted; it remained on hold in spite of substantial risks to the inflation outlook and significant currency weakness.
The threat of a proxy war between the US and Iran in Iraq has pared back some of the recent gains of “risk-on” currencies.
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