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Dollar Retreat: Risks for Asian Financial Markets?

 

A strong US dollar is at the "core of the trade," stemming from a policy mix of internal tax cuts and external tariffs. The US dollar index touched the 108 mark last Friday, but the trend this week has been bleak, with a close below the 107 level overnight on Monday, as the market seems to be gradually shifting towards the "Bessent Trade."

On November 22, local time, hedge fund investor Scott Bessent was nominated by the President-elect of the United States as the next Treasury Secretary. He is considered by Wall Street to be a market-friendly individual (supporting tax cuts and deregulation), with more pragmatic views on tariff policies and a hawkish stance on fiscal budgets. Therefore, after the announcement of the nomination, the US dollar trend cooled, while the US stock market continued to rise.

However, several market participants told reporters that the temporary weakening of the US dollar may be a short-term profit-taking, and the "trade" may continue, with Bessent's policy orientation not deviating too much. It is not difficult to find from Bessent's recent column article (Markets Hail Trump’s Economics, the market welcomes economics) that Bessent himself is a supporter, expressing support for the policy, and he even refuted the warnings of 23 Nobel laureates in economics against the economic agenda.

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Recently, almost all non-US currencies have set new lows against the US dollar, and the Asian market is particularly anxious about the potential tariff stick. Emerging markets saw a total outflow of $3 billion last week, with South Korea (-$700 million) accounting for the main part. Goldman Sachs stated that the new US administration may decide to impose additional tariffs on markets with larger bilateral trade deficits, many of which are Asian economies. Smaller, export-oriented Asian economies are far more sensitive to tariffs than China, as their total exports (especially to the US) usually account for 2 to 3 times the proportion of China's GDP.

"Bessent Trade" sees a strong US dollar pullback

As of 19:15 on November 26, Beijing time, the US dollar index broke through 107, reporting 106.7, and the trend of US dollar bulls temporarily taking profits is obvious.

The "Bessent Trade" refers to the global financial market's dynamic response after nominating the hedge fund manager Bessent as the Treasury Secretary. Bessent, 62, as an experienced Wall Street investment expert, is considered a stabilizing force in economic policy. His nomination has sparked market optimism, driving global stock markets up and US Treasury yields up, showing expectations of strong economic growth in the second term.

Currently, the US national debt has exceeded $36 trillion. The market generally believes that this astronomical figure of debt mainly comes from the government's excessive spending. He will immediately start to reduce federal government spending, calling this plan "the Manhattan Project of our time."

"The difference is that Bessent is considered to have more pragmatic views on tariff policies and is a hawk on fiscal budgets, so the US dollar has cooled down, but the US stock market's rise is unaffected," Jia Shen Group senior analyst Jerry Chen told reporters. With the US dollar's pullback, the euro rebounded 0.75% overnight, closing close to 1.05, the Australian dollar was basically flat at 0.6503, and the US/Japan slightly closed lower at 154.22.

At present, the market's reaction is mainly due to investors' confidence in Bessent's management ability in fiscal challenges, especially in promoting deregulation, expanding energy production, and other growth policies, which may alleviate the uncertainty brought by trade tariffs and inflation. Analysis points out that Bessent may suggest gradually implementing tariffs to reduce market fluctuations, which is seen as a more pragmatic approach compared to other potential nominees.

However, the rebound of non-US currencies is still a long way off. One said that he would increase tariffs on Mexico and Canada by 25% after taking office and increase tariffs on China by 10%. This statement led to a全线下跌 of non-US currencies on Tuesday, with the US/Canada jumping by 1%.

Compared to this, traders believe that the US dollar's pullback is more due to "gravity." Forex expert and general manager of Zhejiang Merchant Zhongtuo Group's financial market business department, Liu Yang, told reporters: "There is no asset that keeps rising, and it's too cold at high places. 108 should be about the high point of the US dollar index this year, and the market tends to wait and see next year."

Traders watch the implementation of US policy in 2025

Whether it's the US dollar, US stocks, or Bitcoin, after a significant climb, "watching" is the mainstream attitude of current institutions, and the specific policy implementation of the new US government in early 2025 will become the focus.

In addition to the Treasury Secretary, several key positions have also been nominated, such as the Secretary of Agriculture, Secretary of Labor, Secretary of Housing and Urban Development, and Director of the Drug Administration. This means that with about 50 days left before officially taking office, he has nominated all cabinet members.

The community believes that according to the current series of nominations, future policies may not differ much from his campaign promises. Moreover, this cabinet layout is very different from his first term, prioritizing the selection of loyal supporters for important positions. In the first term, he was hindered by internal disputes. Now, he seems to be focusing on transforming the federal government to fit his personal ideals. However, even if the Republican Party controls the Senate, some of his nominees may still face a difficult confirmation process.

For example, the Secretary of State nominee Rubio is a Florida senator, and 53-year-old Rubio has a tough stance on China, Cuba, and Iran. Rubio supports his policies, such as shifting from supporting the naturalization of illegal immigrants in the early years to supporting military expulsion plans.

Wall Street institutions generally predict that the US economy and US stocks will still perform well, and Goldman Sachs has even raised the S&P 500 target to 6500 (previously 6300). As of the closing on Tuesday morning, Beijing time, the S&P 500 is just one step away from 6000.

Goldman Sachs' Chief US Economist Jan Hatzius believes that the Republican Party's recent comprehensive victory may bring policy changes in three key areas. First, the institution expects the US to impose additional tariffs on Chinese imports and cars, leading to an actual tariff rate increase of 3 to 4 percentage points; second, Goldman Sachs expects the US's stricter policies to reduce net immigration to 750,000 people per year, slightly lower than the pre-pandemic average of 1 million people per year; third, it is expected that the tax cuts expiring in 2017 will be fully extended, and there will be moderate additional tax cuts.

These changes are significant. The above institutions expect the US GDP growth rate in 2025 to exceed expectations again, with 2.4% in the fourth quarter and 2.5% for the whole year. In addition, inflation may face upward risks. The Federal Reserve is expected to continue cutting interest rates in 2025, then slow down the pace of rate cuts before the easing cycle ends, with an expected final rate of 3.25% to 3.5%, 100 basis points (BP) higher than the previous cycle. The Federal Reserve may continue to slightly raise its estimate of the neutral interest rate because high fiscal deficits and sustained risk sentiment are offsetting the impact of higher interest rates on demand.

Standard Chartered's Global Chief Strategist Robertson said that when the Federal Reserve started this round of rate cuts by 50BP on September 18, the market was priced to expect a rate cut of about 30BP in 2025, and now the market is priced to expect a rate cut of only 50BP in 2025, and the market does not even agree that the Federal Reserve will cut rates by 25BP at the meeting on December 18 this year.

"In the short term, we believe that the market's pricing of rate cuts is somewhat excessive, but the possibility of the US maintaining higher interest rates for a longer period cannot be ignored, especially on the long end of the yield curve. As rate cut expectations recede, the yields of US Treasuries of all maturities are now above 4%," he said.

Non-US currencies find it hard to rebound under tariff risks

Under this background, although the recent strong US dollar has weakened, non-US currencies are also difficult to continue a significant rebound.

Asian currencies may be at the center of the storm. The spillover effect of tariff increases on Asian foreign trade-oriented economies may be more significant. Standard Chartered believes that it will cautiously view the currencies of economies most dependent on trade, as well as the currencies of economies with the highest offshore RMB beta values, including the Thai baht, Korean won, Singapore dollar, and Malaysian ringgit.

During the last round of trade frictions in 2018, the trade-weighted exchange rates of 9 Asian currencies depreciated significantly, which will also pose a dilemma for Asian central banks. A significant depreciation may once again bring the possibility of rising input inflation. In addition, Asian central banks may be reluctant to use rate cuts to stabilize economic growth, thereby exacerbating the risk of currency depreciation (which may trigger capital flight). Currently, interest rates in Asian economies are generally at low levels (except for India, Indonesia, and the Philippines), and once there is a long-term exchange rate fluctuation, rate cuts may become a secondary option.

Goldman Sachs' global economic team believes that the US may announce new tariffs shortly after January 20 next year. Their base assumption is that these new tariffs mainly target the goods in lists 1 to 3 during the 2018-2019 trade frictions (mainly intermediate goods and capital goods, not consumer goods), leading to an effective tariff rate increase of 20 percentage points.

However, other Asian economies may face greater challenges. Morgan Stanley believes that in recent years, Vietnam and South Korea have the largest trade increases relative to the US, and smaller, export-oriented Asian economies are far more sensitive to tariffs than China.