Asian Currencies Fallen!

These days, most of headlines discussing about financial market distress in the US is ushering in a new reality to the Asian markets. True, Asia’s banking systems are by no means facing nearly as severe a situation as those of the US or Europe. But even so, the impact of events in the US is likely to have important implications on Asia’s foreign exchange market and monetary policy.

Somehow, in Asia’s currency markets, developments in the US are likely to affect forex rates in two ways. On one hand, the turmoil in the US financial markets should spell a weaker US dollar; this would imply Asian currencies should be under pressure to appreciate. On the other hand, weakness in the US economy in the coming quarters, owing to tighter credit market conditions, will take its toll. The latter should lead to a further deceleration of exports from Asia to the US and the rest of the world. This suggests depreciation pressure will push down Asian currencies. A weaker US financial industry is also likely to lead to a selloff of Asian equities and assets in the US and elsewhere. 

Again, the turmoil in the US financial market and sharp decline in oil prices are likely to change the monetary policy landscape in the rest of Asia. Before recent events, I had thought the dominant monetary policy stance in Asia would be tightening through end-2008. However, expected weaker exports and an increasing negative wealth effect have stepped to the fore — these certainly put pressure on economic growth, although the banking system remains sound across Asia. Elsewhere, inflationary pressure is seen losing momentum as the two biggest contributors to the CPI inflation rate — oil prices and food prices — are likely to start to moderate within the next few months.

With these developments, most Asian monetary authorities should now be changing their stance from tightening to neutral. This policy change should be followed by monetary easing around end-2008, when the market is likely to clearly see that exports are decelerating.

Next question: Rough road ahead?