Asia FX Monthly Outlook

To be weighed by another substantial Fed rate hike

Monetary policy divergence and relentless dollar strength have led Japan and China towards currency intervention

This year’s strong USD performance, driven by aggressive Fed tightening, has been particularly challenging to countries with divergent monetary stances against the US. The Japanese yen has been especially pressured by this widening policy gap, as the BoJ stringently commits to its ultra-loose policy rate of -0.1% in a bid to raise long-term inflation to its elusive 2.0% target. As a result, Japan’s government has spent over USD50.0b in multiple forex interventions since mid-September to stem the yen’s rapid decline. This may continue over the next few months as Japan has significant space for several more rounds of intervention, considering its massive USD1.2t in foreign reserves. However, its effectiveness will likely remain limited until the Fed completes it tightening cycle, and may only serve to slow the yen’s steady descent.

The Chinese yuan faces similar challenges, with pressures from a stronger dollar, PBoC’s accommodative monetary policy stance, and China’s weakening economy amid the sustained zero-COVID-19 policy. The PBoC has already initiated some measures to defend the currency, such as changing the reserve requirements for foreign currencies in order to raise the cost of shorting the yuan. There are also signs that China has intervened in forex markets, with reports indicating that state-owned banks likely sold dollars towards the end of October, which led to a marked bounce for the yuan. However, China is unlikely to intensify intervention measures going forward, as it would drain the country’s foreign reserves and potentially lead to further outflows as markets may fear stronger capital controls, even as policymakers recently reiterated commitments toward market reforms.