Powell pushing Asia into a new financial crisis

TOKYO – The mid-1990s vibe emanating from Federal Reserve headquarters in Washington is becoming harder for dollar bulls to dismiss. In the short run, the Fed’s decision to hike interest rates Wednesday by 75 basis points, not a full percentage point, was greeted by investors as welcome news. What’s not, however, is how Fed Chairman Jerome Powell’s past mistakes are about to wreck the second half of Asia’s 2022. Powell is surely determined to make up lost ground. Namely, for sitting back in 2021 and calling US inflation “transitory” instead of confronting it with sizable rate hikes — back when it might have made a difference. “The question is why did they delay that, why did they delay their response?” former Fed chairman Ben Bernanke told CNBC. “I think in retrospect, yes, it was a mistake. And I think they agree it was a mistake.” Coming now, though, as consumer prices surge at a 9.1% pace, the 150 basis points worth of monetary braking the Fed has done since June — the biggest moves since the mid-1990s — and more hikes on the way will do more to devastate Asia’s next six months than tame US overheating risks. The Fed’s hikes are their own nightmare for Xi Jinping’s China. Rising US rates put China’s giant export engine at risk. It complicates things for highly indebted mainland property developers struggling to avoid default. And then there’s the nearly US$1 trillion of state wealth parked in US government debt. The yen’s dwindling value – down 18% so far this year – is a crisis in slow motion for Prime Minister Fumio Kishida and Bank of Japan Governor Haruhiko Kuroda. Asia’s No 2 economy is importing increasing waves of inflation via food and energy markets. The Thai baht is already down more than 10% against the dollar this year. In Manila, the new Ferdinand Marcos Jr. regime is struggling with a peso down 9.3%. As costs of food and other vital items surge, millions of Philippine families who escaped poverty over the last decade risk sliding back under the line. Both the Malaysian ringgit and Indian rupee are down nearly 7%, while the Indonesian rupiah has lost 5% of its value. The won is down more than 9.5% this year, causing its own headaches for the Bank of Korea. From Taiwan to Vietnam, powerful capital outflows into higher-yielding dollar investments are adding to pressures on Asian governments. Asia’s currencies are getting pummelled by the strong dollar. Photo: Stock / Getty Images. As Asia braces for more to come, traders are buzzing about a “reverse currency war,” whereby central banks favor stronger exchange rates to reduce imported inflation risks. It’s easier said than done, says Harvard University economist Jeffrey Frankel. “It is impossible for all countries to pursue such strategies because they cannot all move their exchange rates in the same direction at the same time,” Frankel says of fallout from runaway dollar strength. Ironically, the US Congress on Wednesday, hours after the Fed tightened, showed Powell a better way to save the day. The Senate moved to deploy $52 billion in subsidies to semiconductor manufacturers and reinvigorate science and technology to raise productivity. Its broader $280 billion “Chips and Science Act” endeavors to boost competitiveness at a moment when China is investing trillions in owning the future of innovation. Many of the price pressures imperiling US growth are coming from the supply side — from Covid-19 disruptions to surging commodity prices to Russia’s Ukraine invasion to weak tech investment. The Fed, of course, has very little influence over steps by government and industry to increase economic efficiency. Lawmakers incentivizing tech investments is arguably a step in the right direction. It’s not enough, of course, and President Joe Biden’s White House needs to raise its sights. China is spending trillions of dollars to dominate the future of semiconductors, biotechnology, 5G, electric vehicles, aviation, artificial intelligence, renewable energy and green infrastructure. It’s all part of President Xi Jinping’s “Made in China 2025” scheme. In the meantime, Powell’s Fed is now engaged in a 1990s-style battle with the ghosts of bad decisions past. The worst, arguably, was Powell caving to politics in 2019, when his team began cutting interest rates when the US least needed it. In August 2019, when Powell gave in to then-president Donald Trump, US growth was buoyant, stocks were up and the job market was sizzling. Trump, though, was enraged the Fed was raising rates on his watch. That rate hike cycle started in 2015, when Janet Yellen chaired the Fed. After meticulously ending post-Lehman crisis quantitative easing, the Yellen Fed in December 2015 boosted rates for the first time since 2006. Powell pushed on with normalizing US rates after replacing Yellen in February 2018. Then-US president Donald Trump pressured Powell against raising rates. Photo: Agencies Then the Fed got trump

Powell pushing Asia into a new financial crisis

TOKYO – The mid-1990s vibe emanating from Federal Reserve headquarters in Washington is becoming harder for dollar bulls to dismiss.

In the short run, the Fed’s decision to hike interest rates Wednesday by 75 basis points, not a full percentage point, was greeted by investors as welcome news. What’s not, however, is how Fed Chairman Jerome Powell’s past mistakes are about to wreck the second half of Asia’s 2022.

Powell is surely determined to make up lost ground. Namely, for sitting back in 2021 and calling US inflation “transitory” instead of confronting it with sizable rate hikes — back when it might have made a difference.

“The question is why did they delay that, why did they delay their response?” former Fed chairman Ben Bernanke told CNBC. “I think in retrospect, yes, it was a mistake. And I think they agree it was a mistake.”

Coming now, though, as consumer prices surge at a 9.1% pace, the 150 basis points worth of monetary braking the Fed has done since June — the biggest moves since the mid-1990s — and more hikes on the way will do more to devastate Asia’s next six months than tame US overheating risks.

The Fed’s hikes are their own nightmare for Xi Jinping’s China. Rising US rates put China’s giant export engine at risk. It complicates things for highly indebted mainland property developers struggling to avoid default. And then there’s the nearly US$1 trillion of state wealth parked in US government debt.

The yen’s dwindling value – down 18% so far this year – is a crisis in slow motion for Prime Minister Fumio Kishida and Bank of Japan Governor Haruhiko Kuroda. Asia’s No 2 economy is importing increasing waves of inflation via food and energy markets.

The Thai baht is already down more than 10% against the dollar this year. In Manila, the new Ferdinand Marcos Jr. regime is struggling with a peso down 9.3%. As costs of food and other vital items surge, millions of Philippine families who escaped poverty over the last decade risk sliding back under the line.

Both the Malaysian ringgit and Indian rupee are down nearly 7%, while the Indonesian rupiah has lost 5% of its value. The won is down more than 9.5% this year, causing its own headaches for the Bank of Korea. From Taiwan to Vietnam, powerful capital outflows into higher-yielding dollar investments are adding to pressures on Asian governments.

Asian currency banknotes interspersed with US dollars. Photo: iStock/Getty Images. Asian currency banknotes interspersed with US dollars. Photo: iStock/Getty Images.
Asia’s currencies are getting pummelled by the strong dollar. Photo: Stock / Getty Images.

As Asia braces for more to come, traders are buzzing about a “reverse currency war,” whereby central banks favor stronger exchange rates to reduce imported inflation risks. It’s easier said than done, says Harvard University economist Jeffrey Frankel.

“It is impossible for all countries to pursue such strategies because they cannot all move their exchange rates in the same direction at the same time,” Frankel says of fallout from runaway dollar strength.

Ironically, the US Congress on Wednesday, hours after the Fed tightened, showed Powell a better way to save the day.

The Senate moved to deploy $52 billion in subsidies to semiconductor manufacturers and reinvigorate science and technology to raise productivity. Its broader $280 billion “Chips and Science Act” endeavors to boost competitiveness at a moment when China is investing trillions in owning the future of innovation.

Many of the price pressures imperiling US growth are coming from the supply side — from Covid-19 disruptions to surging commodity prices to Russia’s Ukraine invasion to weak tech investment. The Fed, of course, has very little influence over steps by government and industry to increase economic efficiency.

Lawmakers incentivizing tech investments is arguably a step in the right direction. It’s not enough, of course, and President Joe Biden’s White House needs to raise its sights.

China is spending trillions of dollars to dominate the future of semiconductors, biotechnology, 5G, electric vehicles, aviation, artificial intelligence, renewable energy and green infrastructure. It’s all part of President Xi Jinping’s “Made in China 2025” scheme.

In the meantime, Powell’s Fed is now engaged in a 1990s-style battle with the ghosts of bad decisions past. The worst, arguably, was Powell caving to politics in 2019, when his team began cutting interest rates when the US least needed it.

In August 2019, when Powell gave in to then-president Donald Trump, US growth was buoyant, stocks were up and the job market was sizzling. Trump, though, was enraged the Fed was raising rates on his watch.

That rate hike cycle started in 2015, when Janet Yellen chaired the Fed. After meticulously ending post-Lehman crisis quantitative easing, the Yellen Fed in December 2015 boosted rates for the first time since 2006. Powell pushed on with normalizing US rates after replacing Yellen in February 2018.

Photo: Reuters/Carlos BarriaPhoto: Reuters/Carlos Barria
Then-US president Donald Trump pressured Powell against raising rates. Photo: Agencies

Then the Fed got trumped. In speeches and tweets, Trump attacked Powell’s rate hikes, even threatening to fire his hand-picked Fed chief. Powell acquiesced and began lowering rates.

That U-turn had three negative consequences. One was adding liquidity the globe’s biggest economy didn’t need. Second, it wasted monetary ammunition the Fed could’ve used when the pandemic hit. Three, it did grave damage to the perception of Fed independence.

This latter problem makes today’s echoes of the 1990s all the more relevant. The Fed’s 1994-1995 tightening cycle, under then-chairman Alan Greenspan, greatly angered the Washington political establishment. His doubling of short-term rates in just 12 months caused great collateral damage — in Mexico, on Wall Street, in municipalities around the US and, especially, in Asia.

The dollar’s epic rally then — as now — put Asia at grave risk. By 1997, the strain on dollar pegs from Bangkok to Jakarta to Seoul became impossible to defend. A wave of devaluations set in motion the 1997-98 Asian financial crisis.

Is history about to repeat itself? After two 0.75 percentage-point hikes in short succession, Powell’s team seems to be setting the stage for a full one percentage-point hike in the weeks ahead.

Washington’s fiscal position raises the stakes. With US debt now well above $30 trillion, the fallout from aggressive Fed hikes could be far bigger now than in the 1990s.

This speculation virtually ensures the US will continue to hoover up capital from all corners of the globe. The outflows are sure to accelerate as the Fed signals more assertive taps on the monetary brakes.

Economist Jonathan Fortun at the Institute of International Finance views these actions as part of a perfect storm of risk for markets everywhere.

“Mounting global recession risk is weighing on emerging market flows as anxiety builds over geopolitical events, tighter monetary conditions and realized inflation,” Fortun says. “The continued volatility in equity markets has hurt the outlook considerably.”

Fortun notes that “we are in a global interest rate and high inflation shock” in the second half of 2022. “Longer-dated government bond yields have risen sharply across advanced economies, tightening financial conditions, weighing on growth, and pushing up risk aversion. This mechanism is weighing on flows to emerging markets. We see that the current outflow episode is similar in scale to the RMB devaluation scare in 2015 and 2016.”

The Monetary Authority of Singapore is moving aggressively to protect its dollar against US buck strength. Photo: iStock / Getty Images

Ravi Menon, who heads the Monetary Authority of Singapore, is sounding the alarm about the impact of a strong dollar, 25 years after the ‘97-98 crisis. Menon’s team finds that “a 1% appreciation of the US dollar is associated with net capital outflows of 0.3% of emerging-market GDP in the following quarter.” Over the last 12 hours, MAS officials leaped into markets to support the Singapore dollar.

This augurs poorly for growth in emerging Asia. In Indonesia, the Philippines and Thailand, currencies are sliding at accelerating rates just as surging global commodity prices are raising inflation risks. Already, Philippine inflation exceeds 6%, well above government targets. That has the Marcos government struggling out of the gate with twin food and energy crises.

The Fed, of course, had myriad opportunities throughout 2021 to make down payments against inflation. Even though many of today’s pressures come from the supply side, Fed inaction enabled the trend. It could have sent any number of monetary shots across the bows of corporate CEOs angling to hike prices or speculators driving commodities higher.

At the very least, acting might have rebuilt some of the Fed credibility Powell lost bowing to Trump’s demands. Now, as Powell races to make up for lost time, Asia is directly in harm’s way.

Some economists, including former Goldman Sachs analyst Jim O’Neill, worry a continued yen slide could force China to devalue. O’Neill thinks that’s all too possible if the yen heads toward 150 to the dollar (from 136 now).

Japan’s $1.45 trillion Government Pension Investment Fund could start reporting sizable losses thanks to the yen’s drop. Japan’s government, meantime, is cobbling together yet another massive fiscal stimulus package to support flatlining growth.

The US, UK and Australia won’t be far behind as global headwinds hit business confidence. These fiscal realities – and fallout from the wrecking-ball dynamic surrounding the dollar – could have unpredictable geopolitical fallout.

Meanwhile, the availability of ready financing for the Group of Seven’s infrastructure plan to rival China’s Belt and Road Initiative is becoming even more doubtful. China’s massive trade surpluses continue to finance trade and investment from Mexico to India. But the depths of the G7’s pockets to come up with the avowed $600 billion are becoming more and more questionable.

Even so, risks are growing with Powell’s desperation to repair the Fed’s reputation and the dollar’s additional gains to come.

A cashier counts dollar bills at a restaurant in the US. Photo: AFP

“We read Chair Powell’s press conference as more hawkish than the market’s interpretation,” says Citigroup Inc economist Andrew Hollenhorst. Odds are, he adds, inflation trends will “push the Fed to hike more aggressively than they or markets anticipate,” with a 75 basis-point move in September.

Many punters read great significance into the Fed’s vagueness about where rates are headed next. Yet count Mike Wilson, Morgan Stanley’s chief investment officer, among those worried rising hope that the Fed is winding down its tightening cycle is a “trap.”

Jane Foley, head of FX strategy at Rabobank, speaks for many when she says that a reversal of the dollar’s surge “may not happen until the market is convinced that the Fed has changed course.” That is almost sure to make Asia’s road to 2023 a perilously rocky one. Perhaps as bad, or even worse, than the dreaded 1990s.

Follow William Pesek on Twitter at @WilliamPesek