Asia FX Talk - A sharp shift in US rate cut expectation

Ahead Today

G3: US 1y inflation expectation

Asia: India inflation and industrial production

Market Highlights

Markets have become calmer following recent excessive volatility, with USDJPY hovering around the 145.00-147.00 level, while the DXY US dollar index has recaptured the 103-level. US 2-year yield has returned to above 4%, as markets have reduced their pessimism about the US economy. Still, markets are pricing for 100bps of US rate cut this year and another 100bps of rate cuts for next year. This marks a sharp repricing of market expectations for the pace of US rate cuts in recent months, which have in turn dampened the US dollar. Given a still resilient US economy, as reflected by the recent pickup in the US ISM services index, and ongoing uncertainty over the upcoming US elections in November, there could still be further repricing of rate-cut expectations.

In a recent speech by Federal Reserve Governor Michelle Bowman, she noted progress in inflation, while pointing out that there are still upside risks to inflation from fiscal policy and geopolitical risks, However, should incoming data point to inflation returning sustainably to 2%, she added that there’s scope for gradual monetary easing to prevent policy from being overly restrictive. 

Meanwhile, recent excessive yen volatility due to a hawkish Bank of Japan has led to concerns among BoJ officials. We think the dust will have to settle before policymakers think about the next policy move.

Regional FX

Asia currencies have mostly strengthened against the US dollar last week. IDR (+1.7%), MYR (+1.6%), and TWD (+1.2%) led gains in the region. However, CNY weakened 0.2%, with negative spillovers to KRW (-0.3%). China CPI inflation was just 0.5%yoy in July, remaining subdued and reflecting weak consumer confidence and domestic demand. INR also fell by about 0.3%, possibly impacted by recent market volatility. With the RBI keeping the policy rate elevated, this should help contain the pace of rupee depreciation. China’s activity data (retail sales, industrial production, and urban fixed asset investment) and the BSP policy rate decision will be the next key focus in Asia this week.