Finance

Dollar Strength Forces Asia to Face Tough Choice Between Accepting Weaker Currencies or Pushing Back

Central banks in Asia face a tough decision as they confront dollar strength. The Fed's hawkish cut forces these nations to decide whether to defend their currencies or let them weaken further.

Central banks across Asia face a tough decision following the Federal Reserve's hawkish cut — defend their currencies at a significant cost, or let them weaken further in the face of increasing dollar strength.

Dollar Strength Forces Tough Decisions for Asia's Central Banks

The Federal Reserve’s recent policy shift, signaling concerns about inflation, has led to a sharp depreciation in Asian currencies. On Thursday, the Indian rupee hit a record low against the dollar, and the Korean won fell to its weakest level since the 2008 financial crisis. The Bloomberg Asia Dollar Index dropped by approximately 0.4%, reflecting widespread currency weakness across the region. In response, China’s central bank sought to support the yuan by adjusting its reference rate.

The situation is forcing central banks in Asia to choose between two difficult options: fight back against the dollar's strength with expensive interventions or stand by and watch their currencies continue to falter. This predicament comes as the Asian currencies have already lost almost 4% against the dollar this year, even after the Federal Reserve cut interest rates.

“It is hard to fight the higher dollar strength against Asian currencies when it is primarily dollar-driven,” said Wee Khoon Chong, a strategist at BNY Mellon in Hong Kong. “Regional central banks will have to play defense and try to smooth out depreciation pressure to keep an orderly FX market.”

Diverging Approaches to Dollar Strength Across Asia

Different central banks in Asia are adopting varying strategies to address the impact of dollar strength. Bank Indonesia has been vocal about its interventions in the domestic market, signaling to traders that it is taking an active stance. The Reserve Bank of India, on the other hand, has employed a mix of offshore and onshore contracts to bolster the rupee, though it has not commented publicly on these actions. Other central banks in the region are closely monitoring market developments but have yet to make significant moves.

PBOC Offers Support to Yuan Amid Dollar Strength

The People's Bank of China (PBOC) ramped up its support for the yuan on Thursday by setting a daily reference rate stronger than analysts’ forecasts. This so-called fixing, which limits yuan movements by 2% on either side, is the strongest it has been relative to projections since July.

“The PBOC will continue to restrain the upside pressures on dollar strength for now, but I think the exchange rate will break to new highs in 2025 with the outbreak of a second US-China trade war,” said Alvin T. Tan, head of Asia FX strategy at RBC Capital Markets.

To further support the yuan, Chinese state banks sold the dollar in the onshore market without offering to purchase the greenback, according to anonymous traders.

Fed’s Hawkish Cut Sends Shockwaves Across Asia's FX Market

Currency traders across Asia reacted to the Fed’s hawkish rate cut, which initially reduced interest rates but also included a clear message about ongoing concerns over inflation. The Fed’s new projections for 2025 suggest a more conservative outlook, with only a half-percentage-point reduction in interest rates next year — half of what was expected in September.

This change in focus from concerns about the labor market to inflation marks a significant shift in the Fed’s policy stance. Federal Reserve Chairman Jerome Powell acknowledged that the central bank’s inflation projections have "kind of fallen apart," adding to the uncertainty surrounding the future of dollar strength.

Conclusion: A Strategic Crossroads for Asia

As dollar strength continues to challenge Asian currencies, central banks across the region must make difficult decisions about how to respond. The impact of these choices will have far-reaching consequences for the future of Asia's currency markets and their ability to withstand the pressures of a strengthening dollar.