Why the US dollar is causing chaos across Asia

Emerging-market currencies have tumbled this year as the dollar has gone from strength to strength. Taiwan's currency dropped to the lowest level in almost eight years this week, India's rupee slumped to a record, and Malaysia's ringgit is close to the weakest since the Asian financial crisis in 1998. All except one of the 23 main developing-nation currencies tracked by Bloomberg have fallen against the greenback this year.

What's behind the dollar rally this year?

The big tailwind behind the dollar has been US "exceptionalism." While much of the world economy is only seeing moderate growth, American data from employment to retail sales to inflation has frequently beaten analysts' forecasts. This has led traders to trim back bets on Federal Reserve interest-rate cuts, which has helped fuel gains in the greenback. The Bloomberg Dollar Spot Index, which tracks the US currency against 12 of its major peers, has risen by more than 4% this year.

Why have emerging-market currencies been falling?

The rampaging dollar and the prospect of higher-for-longer US interest rates have been the main drivers. The upper bound of the Fed's benchmark is currently at 5.5%, meaning investors can get attractive returns from holding dollars without needing to take the exchange-rate risk of sending funds to emerging markets.

While a number of developing nations do offer a yield advantage over the US, in many cases this has been shrinking. At the start of last year, Brazil's policy rate was 13.75%, Chile's was 11.25% and Hungary's was 13%. Since then, central banks in the three economies have collectively trimmed their key rates by more than 12 percentage points.

Why have Asian currencies been particularly vulnerable?

Asian currencies have suffered some of the largest declines this year largely because central-bank rates in the region are lower than in most other emerging markets. Malaysia's benchmark, for example, is 2.5 percentage points below that of the Fed, a record deficit for the Southeast Asian country. Equivalent rates in Thailand, South Korea, Taiwan and China are also below that of the US.

While US policymakers have been raising borrowing costs over the past two years, China's central bank has been easing policy to support its stuttering economy. This has seen the yuan come under constant pressure, and that has filtered across other Asian currencies too, especially those of South Korea and Taiwan which have close economic links with China.

What are Asian central banks doing to support their currencies?

Growing expectations that US rates will stay high has deterred Asian central banks from cutting their own benchmarks due to fears about potential currency weakness.

Policymakers across the region have also unleashed a number of tools to bolster their currencies. China has used its daily currency fixing to support the yuan, while state-owned banks have sought to boost the currency by selling dollars. Bank Indonesia has dipped into its foreign-exchange reserves to buy rupiah, while Malaysia's central bank has been encouraging state-linked firms to repatriate foreign investment income and to convert it into ringgit.

But central banks know they are treading a fine line. If they deplete foreign reserves too quickly, this may lead to concerns about their long-term financial stability. Even the Bank of Japan, which has plenty of firepower to defend the yen, only intervened directly in the market three times in 2022 to prop up its currency.