Asian Currency

The US dollar poised to be stronger for longer


As interest rate cuts by the US Federal Reserve draw closer, some analysts expect that Asian currencies, which have been chronically weak against the US dollar over the past three years, will at last turn around. From the start of 2021 to the end of March 2024, every Asian currency, bar none, has depreciated against the greenback.

The Singapore dollar has been the best performer, weakening by only about 1.5 per cent.

At the other extreme, the Japanese yen has fallen by a whopping 32 per cent. The Korean won has dropped close to 20 per cent, the Thai baht by 18.2 per cent, the Malaysian ringgit by 15 per cent and the Chinese renminbi by 9.7 per cent.

The overvalued US dollar

By several metrics, the US dollar is overvalued. One yardstick is purchasing power parity (PPP), which measures what a standardised good, or basket of goods, costs in US dollar terms in different countries in order to assess the extent to which those countries’ currencies diverge from their “correct” values.

A widely followed metric is the “Big Mac Index” invented by The Economist magazine, which compares the average price of a McDonald’s Big Mac hamburger in different countries. Since it exists worldwide in a standard size, composition and quality, the relative price of a Big Mac is claimed to be a telling (though only partial) indicator of purchasing power – and therefore the under- or overvaluation of a currency.

According to Statista, the average price of a Big Mac in Singapore in January was the equivalent of US$4.96 (S$6.70), whereas in the US, it was US$5.69. The price difference suggests that the US dollar was overvalued against the Singapore dollar by 14.7 per cent.

The same story holds for most currencies outside the euro area and Switzerland, where the Big Mac is most expensive in US dollar terms.

The US dollar is also overvalued by other measures.

In a report on Feb 24, S&P Global reported that, by its calculations, the greenback was overvalued against all Asian emerging market currencies in January, by an average of 16 per cent, ranging from 1.7 per cent against the Chinese renminbi to 31 per cent against the Malaysian ringgit. It concluded that “there is significant scope for Asian emerging market currencies to climb in real terms against the US dollar”.

In the long run, this may be true. But just as stocks can be overvalued for prolonged spells, the same is true of currencies.

Moreover, there are several forces that influence currency valuations which can cause persistent divergences from their true PPP valuations. There is reason to believe that currently many of these forces favour the continued overvaluation of the US dollar, especially against Asian currencies.

Yield gaps favour the dollar

One factor is relative interest rates, which affect the yields that currencies offer.

Expectations that the US Federal Reserve will cut interest rates have been dramatically pared back since December. At that time, interest rate futures were pricing in as many as five 25 basis point rate cuts during 2024, beginning in March; an overall drop of 1.25 per cent.

But the inflation numbers, which were heading down, have recently gone in the opposite direction. The Fed’s favoured measure of inflation – personal consumption expenditure – perked up to an annual rate of 2.5 per cent in February, up slightly from January.

Shipping disruptions in the Red Sea, the Panama Canal and recently in Baltimore on the US East Coast have created new upside inflation risks.

So now, the Fed’s message, repeated by its chairman Jerome Powell on March 29, is that it is in no hurry to cut rates, which currently hover around 5.5 per cent. While a slim majority of the Fed’s rate-setting committee supports three rate cuts in 2024 – the same as markets expect – the number backing two cuts or fewer has risen since December.

Rate cut projections for 2025 and 2026 have also been scaled back. In short, the Fed’s pivot to rate cutting has been both delayed and toned down, which is positive for the US dollar.

Even interest rate cuts by the Fed do not necessarily mean the dollar will fall. There have been many instances where the dollar has risen despite rate cuts – most dramatically during the global financial crisis in 2008, when the Fed cut rates to near zero. The dollar benefits from safe-haven effects, which amid two hot wars in Ukraine and the Middle East are now very much in play.



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