The “dollar wrecking ball” is back.
If you didn’t know better, you’d be inclined to think the likely end of Fed hikes and YTD highs for crude might translate into a weaker greenback, but not so.
Economic divergence between the US and China, a renewed rise in Treasury yields around the seasonal deluge of corporate debt issuance+ and the notion that a strong US economy will countenance a lengthy stay at terminal for the Fed (or at least limit the scope and rapidity of rate cuts in 2024), all argued for more dollar strength as August melted into September.
This is déjà vu all over again for the rest of the world, and particularly for authorities in Japan and China who, just like last September, are battling to defend their currencies.
Japan hasn’t intervened again yet, but traders were on watch from last month, when the yen breached levels+ where officials stepped into the market in 2022. Vice Finance Minister Masato Kanda offered a stark warning on Wednesday. “If these moves continue, the government will deal with them appropriately,” he said, adding that Japan “won’t rule out any options.”
Tokyo worries more about the rapidity of yen depreciation than any level. Either way, it’s obvious Japan is prepared to intervene if the market pushes the issue much further. Recent FX developments, Kanda fretted, “cause uncertainty to businesses and households, which will have a negative impact on the economy.”
It’s the same story over and over again with Japan: The BoJ still has a hard ceiling for JGB yields, even if that ceiling is now higher than it was. Rate differentials are predisposed to moving in favor of the dollar.
In China, the PBoC leaned into the fix to the tune of 1,139 pips. It was the fourth instance of 1,000-pip pushback in a month.
Beijing’s efforts to brake yuan depreciation became more urgent this summer as the currency slid to the weakest levels against the greenback in 15 years. Banks sold dollars and the PBoC engineered an offshore funding squeeze, all to no obvious avail. Last week, officials cut banks’ FX reserve ratio.
Outside of draconian measures, there’s not much China can do. The PBoC is allowing the move, but they’re plainly uncomfortable with it on some days. If Beijing resorts to heavy-handed intervention or institutes stricter capital controls, markets would view that as a step backwards on the path to yuan internationalization.
The fundamentals behind the yuan’s slide against the dollar are impossible to ignore. The Chinese economy is beset and US yields remain elevated. The yuan will get some support from exporters selling dollars later this year (i.e., converting dollar proceeds for shipments of holiday goods to yuan for cash management into year-end), but that’s a Q4 dynamic.
As ever, ongoing dollar strength tends to be risk-negative. It puts emerging market policymakers in a tough spot (they can’t ease for fear of worsening depreciation pressure, and defending their currencies entails burning reserves) and acts as a de facto liquidity drain through a number of channels.
Higher crude in tandem is insult to injury in some locales. “The vicious three-way dynamic of ‘higher USD, higher UST yields and higher oil [is] again challenging the equities soft-landing zeitgeist,” Nomura’s Charlie McElligott said.
Needless to say, the dollar will also benefit in the event the economic situation in Europe continues to deteriorate, limiting the scope for additional ECB policy tightening.
“Risks look skewed towards more sustained dollar strength than most appreciate — especially against some of the major ‘Challenger’ currencies, including JPY and CNY,” Goldman’s Kamakshya Trivedi remarked. “The euro, in particular, now looks like the fulcrum for FX markets through year-end; if growth in the euro-area looks less resilient than our current expectations and China concerns persist, we would see greater upside for the broad dollar, which may limit the upside for cyclical currencies.”
