Dollar's Biggest Weekly Gain in 1.5 Years Sparks New Currency Defense in Emerging Markets

The Federal Reserve's interest rate cut expectations have been lowered again and again, coupled with the escalation of the situation in the Middle East leading to a surge in demand for safe-haven assets, which together have driven the US dollar to its largest weekly gain in a year and a half last week.

Emerging market economies, especially some Asian emerging market economies, have to wage a "currency defense war" once again.

The US dollar recorded its largest weekly gain in a year and a half

Data shows that the strength of the US economy and the relative safety of the US dollar as the world's largest traded currency have driven the US dollar to its largest weekly gain in a year and a half. Prior to this, after news broke that Iran might take retaliatory actions against Israel, the US dollar and US Treasury bonds surged on the 12th.

Specific data shows that the US dollar index rose by more than 1.4% last week, recording the largest weekly gain since September 2022. On the one hand, after the previously very strong non-farm employment data was released, the US consumer price index (CPI) in March once again exceeded market expectations, leading swap traders to postpone bets on the Federal Reserve's first interest rate cut in June, instead expecting the Federal Reserve to cut interest rates as early as September this year, and the number of interest rate cuts this year has also been reduced to 2 times. This has also exacerbated the divergence in monetary policy between the Federal Reserve and other major central banks around the world. At the same time, concerns about a further escalation of the situation in the Middle East have driven investors to buy safe-haven US dollars last week, also boosting the US dollar.

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Data from the US Commodity Futures Trading Commission (CFTC) shows that as of the week of April 9, asset management companies, hedge funds, and others held about $17.5 billion in net long positions in the US dollar, and these non-commercial traders are currently the most optimistic about the US dollar since the fall of 2022.

Ned Davis Research's Chief Economist Alejandra Grindal said: "From various indicators, at least for now, the US dollar is likely to continue to strengthen. Based on what we currently understand, the possibility of the Federal Reserve not taking action first is increasing. Historically, when other major central banks take action before the Federal Reserve, the US dollar strengthens."

Dominic Schnider, Global Head of Foreign Exchange and Commodities at UBS Global Wealth Management, said: "Compared with other economies with poor economic growth, the Federal Reserve is in a comfortable position to maintain interest rates, and we may see the US dollar continue to rise against other currencies."

Emerging markets wage a "currency defense war" again

The new round of US dollar appreciation has once again put pressure on emerging economies to intervene in exchange rates. As of April 12, most emerging market currencies have recorded declines against the US dollar. The largest declines include the Chilean peso, Thai baht, South Korean won, Brazilian real, and Malaysian ringgit, with declines of 8%, 6.7%, 6.3%, 4.6%, and 3.6%, respectively. In addition, the Philippine peso, Polish zloty, and Indian rupee have also recorded declines. Only the Mexican peso, Colombian peso, and Peruvian nuevo sol have recorded gains, with the latter two gaining only 0.7% and 0.3%, respectively.Officials from South Korea, Thailand, and Poland have recently expressed that they are closely monitoring exchange rate fluctuations and have made it clear that they will intervene if necessary. An official from the Bank of Korea stated that they are closely watching the won's exchange rate after it came under pressure last week. The governor of the Bank of Korea, Lee Chang-yeol, included verbal intervention terminology in his speech on exchange rates last Friday. In Thailand, the baht has depreciated by about 6% against the US dollar so far this year. Thai policymakers have been using various statements to try to appreciate the baht. At the meeting on April 10, Thai central bank policymakers maintained interest rates unchanged, despite Prime Minister Srettha Thavisin's emphasis on the need to relax policy, in order to boost the currency, and stated, "The committee will continue to closely monitor fluctuations in the foreign exchange market." The Polish central bank maintained interest rates unchanged at its meeting on April 4 and reiterated that it might intervene to support the Polish zloty, as a stronger domestic currency helps to curb inflation.

On April 2, the Indonesian rupiah fell to a four-year low. The Bank of Indonesia immediately bought more rupiah and sold US dollars to limit depreciation. Perry Warjiyo, the governor of the Bank of Indonesia, has said that intervention and selling high-yield securities will be the main means of supporting the domestic currency this year. However, the depreciation of the rupiah is not only due to a strong US dollar but also due to investors' concerns about the spending plans of the newly elected president, Prabowo.

The Central Reserve Bank of Peru unexpectedly cut interest rates last week. According to media reports, the Central Reserve Bank of Peru has been frequently selling US dollars in recent months to appreciate the Peruvian nuevo sol. Officials in the country have previously stated that the goal of intervention is to reduce exchange rate fluctuations.

It is worth mentioning that in the past month, the currencies with the largest decline against the US dollar are mainly Asian currencies, and thus the central banks with the greatest intervention efforts are also concentrated in Asia. Marcela Chow, a global market strategist at J.P. Morgan Asset Management, said, "Currently, we do indeed see a lot of verbal intervention from different central banks. Given that the Federal Reserve seems unlikely to relax policy soon, Asian currencies may weaken further, and the relevant authorities may need more verbal intervention."

"Central banks in Asia cannot let their guard down," said Paul Mackel, head of global foreign exchange research at HSBC, noting that weak currencies tend to exacerbate price pressures. "This may mean that the last mile of inflation is not only difficult to handle for the United States but also for many other economies."

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