Avalanche alert: China may dump dollars when Fed eases rates – Asia Times
Since the mid-1990s, the US Federal Reserve has had a somewhat shaky past in Asia.
Between 1994 and 1995, the US central bank past tightened with the same intensity as it did recently. The 1997-98 Eastern problems, which resulted from a runaway dollar rally destabilizing the region’s currency pegs, was caused by the short-term rate increase in 12 months.
Since then, the 2008″ Lehman impact” that the Fed was slow to see coming and the 2013 “taper kid” have overwhelmingly rocked Asian areas.
Asia also bore the brunt of the Fed’s 2022-2023 tightening period. Epic ripples of capital scurrying toward US assets as the currency’s surge in response to Fed Chairman Jerome Powell’s price hikes resulted in spectacular waves of funds.
However, could the Fed’s rate reductions cause a different sort of tumult in Asia? If analyst Stephen Jen is correct, it certainly was.
As Team Powell undoes its most recent price hike campaign, the CEO of Eurizon SLJ Capital anticipates Chinese companies to chuck about US$ 1 trillion in dollar-denominated assets.
In truth, Jen predicts something of an “avalanche” as a strengthening dollar sends tides of repatriating money China’s manner, upending dollar industry in the process.
Granted, Jen has warned of this dollar-dumping active for a couple of years today. In June 2023, for instance, Jen argued that” Taiwanese corporates continue to hoard cash. Foreign companies ‘ total investment is increasing as a whole. The economy’s higher have perhaps at present seem enticing to Chinese entities, but this construction is ultimately unpredictable”.
The scenario Jen has been advising about is “prospective rate cuts by the Fed and/or an economic reacceleration in China could lead to a precipitous fall” in the dollar-yuan rate” as corporate treasurers in China scramble to sell the dollars they do n’t need to have.”
Since the Covid-19 pandemic, mainland companies have gobbled up more than$ 2 trillion of overseas investment, a bet on higher-yielding assets than punters often find in China. As Powell begins ratcheting levels lower, those assets may grow less appealing.
Up to US$ 1 trillion will be on the move as a significant number of island companies decide to return funds, according to Jen. Interestingly, Jen points out that his guestimate may be” conservative”.
Then, as Powell declares” the time has come for legislation to change” toward less restrictive problems, Chinese selling dangers may be upon us. It’s worth noting, Jen adds, that companies swapping out of dollar assets could see the yuan , strengthening by up to 10 %.
Additionally, it’s important to point out that the resettlement fluid that is developing throughout China could reach businesses in Asia.
This is n’t a risk many have on their Bingo cards. Powell’s vow on August 23 to” we will do everything we can to help a strong work industry as we make more progress toward price balance” has frequently boosted Asia’s markets.
The same with Powell’s confidence that the US can achieve a so-called” soft landing”, a remarkably rare occurrence. There is good reason to believe that the economy will return to 2 % inflation while maintaining a robust labor market, Jen tells Bloomberg.
Asian bourses were cheering when they learned that Powell “has rung the bell for the start of the cutting cycle,” according to Seema Shah, principal global strategist at Principal Asset Management.
The real gains could be in Asia’s “laggard” markets, notes Chetan Seth, strategist at Nomura Holdings. We believe that the relatively safe harbor is likely to be markets and sectors that are uncrowded ( parts of ASEAN ) and more domestically driven markets ( India/ASEAN), as Seth writes in a recent note. Investors in this situation must be much more cautious and reduce their investment in Asian cyclical markets, like those in North Asia.
Yet other risks abound. Consider Jen to be one of the economists who worry that central banks from Washington to Tokyo have recently injected too much stimulus into the global financial system, causing inflation.
As Powell said in July:” Go too soon, and you undermine progress on inflation. Wait too long or do n’t go fast enough, and you put at risk the recovery. And so, we have to balance those two things. It’s a rough balance”.
Problem is that the costs of a policy error are rapidly rising due to the US’s high and rising national debt, which has recently surpassed US$ 35 trillion. Just a few months before Americans vote on November 5 to choose a new president, this milestone was reached.
Democratic nominee Kamala Harris provides details on spending plans that will add trillions of dollars to the public debt in one corner. Donald Trump, too. Trump makes hints that removing the Fed’s role as independent arbitrator of US interest rates, in addition to another multi-trillion tax cut that is currently being funded by the government.
Trump browbeat Powell into cutting rates in 2019 when the US did n’t need it during his first term as president, from 2017 to 2021. Trump also threatened to fire Powell, a previously unheard of threat from a US leader.
In a second term, the” Project 2025″ scheme that Republican activists cooked up for a Trump 2.0 White House could see the Fed’s power curtailed.
In such an uncertain world, though, the Fed pivoting toward monetary accommodation is n’t necessarily straightforward. The view driving this Asian stock rally is “broadly correct”, at least in the medium-term, says Tan Kai Xian, economist at Gavekal Research.
” Rate cuts will reverse the recent contraction in US liquidity, which will support US aggregate demand, after a lag”, Tan notes. ” But in the shorter term, rate cuts will squeeze corporates ‘ interest income, and therefore their profits. This will disproportionately affect large corporations with large cash reserves, which may result in their relative underperformance.
The effect, Tan notes,” will be bigger than commonly believed. Even though the path was indirect, thanks to businesses selling products to households in receipt of stimulus checks, handouts during Covid allowed US companies to build up sizable cash reserves.
When the Fed cuts interest rates, interest income will fall. At least before the lagged boost to aggregate demand kicks in, Tan says,” The near-term drag on corporate profits could discourage capital spending, which would have a dampening effect on US economic growth.” ” In the short term, then, rate cuts could weigh on large-cap US equities relative to bonds”.
Given that the US inflation rate is continuing to decline, Jen believes Powell may raise rates more forcefully than many investors anticipate. The global reserve currency may be under increased downward pressure due to Washington’s dual budget and current account deficits. That, Jen argues, could see the yuan appreciating more than many investors expect.
The yuan’s gains could be even bigger if the People’s Bank of China avoids moves to offset dollar liquidity. Odds are that the yuan will start to rise once the Fed starts cutting interest rates as soon as September 18? If the Fed makes any hints about further easing, the pressure will increase.
This could cause tension between PBOC Governor Pan , Gongsheng and Xi’s economic team. Beijing has been surprisingly tolerant of a rising yuan over the past year despite the fact that global export markets became more competitive.
Xi has been working to gain more confidence in the yuan and stop large property developers from defaulting on their foreign debts. A skyrocketing yuan that nullifies growth prospects may be even worse unwelcome.
The clouds on China’s economic horizon can be seen in this week’s$ 55 billion stock crash , in Temu-owner PDD Holdings. It’s a sign that China’s growth engines are still cooling despite Beijing’s effort to boost household demand.
Additionally, the external sector does n’t appear particularly promising. This week, Canada slapped a 100 % tariff on China-made electric vehicle imports, following the lead of the US and European Union.
Additionally, it is unlikely that the upcoming US election cycle will offer Team Xi a break. Both presidential candidates, Trump and Harris, are trying to outdo each other with anti-China rhetoric and trade policies.
All of this explains why China’s foreign exchange watchdog has been paying close attention to dizzying yuan-dollar movements. And why things might turn out differently than many investment funds currently believe.
” The pressure will be there” on the yuan to rally, Jen tells Bloomberg. We are talking about$ 1 trillion worth of fast money that could be involved in such a potential stampede if we just assume half of this amount is the money that is “footloose” and easily provoked by changing market conditions and policies.
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His back was against the wall by that point, so the timing could n’t have been better. It was not an easy time, he admits. There was little to no money being made, and the statement” We were running out of money then” was true.
