USD weakness to persist in 2024, brightening prospects of Asian assets

As a linchpin of the global financial system, the direction of the USD is influential on how investors allocate their assets. The greenback had been going from strength to strength until its momentum fizzled in 2022. With the snowballing US debt coupled with the Fed's rate cut expectations, BEA Union Investment expects the greenback will continue to come under pressure, brightening the outlook for Asian assets and currencies.

Between 2014 and early this year, the US dollar index (DXY) had risen about 27%. During the pandemic, the Fed lowered rates to zero to prop up the economy, which subsequently pushed asset prices higher and propelled inflation to elevated levels. To reverse course, the central bank tightened its monetary policy by raising interest rates 11 times. High rates boosted the appeal of the dollar, with the greenback rising about 8% in 2022 alone. But heightened rates also fueled worries that growth could be stifled. After peaking at the end of 2022, the dollar pared back gains and has since then failed to revisit its peak. Amid easing inflation and economic growth, markets expect the central bank will soon end its monetary tightening, with the Fed indicating three cuts this year. The US dollar weakness should persist.

Rate cuts will narrow the interest rate differentials between USD and other currencies, and likely prompt the greenback to start depreciating against other currencies. In 2020, the US dollar lost 10-20% during the rate cut cycle; in comparison, the EUR, GBP and the AUD appreciated by 16-40%. When the US halts rate hikes, it does not only bode well for the West, but also for Asia. Fund outflows will become less of a worry for Asian nations when the US dollar stops appreciating. Central banks in Asia can devise their monetary policies according to the country's domestic fundamentals. Asian markets, such as Indonesia, Malaysia, South Korea and Thailand, are in the position to cut rates to shore up their economies. Indonesia could be among the first to lower interest rates, since the country's inflation and currency both remain stable. Furthermore, the Renminbi could also face less downward pressure and the scale of capital outflow could ease.

Rate cuts aside, the ballooning budget and current-account deficits in the US are other reasons that keep a lid on the dollar's ascent. As of the end of last year, the US national debt stood at US$33 trillion, with the prospect of continuously expanding in the years to come, exerting further pressure on the greenback. In recent years, some countries also noticed this trend, and they have trimmed the holdings of their USD-denominated assets and pared back their reliance on the dollar to diversify risks.

Election year brings uncertainties; stay watchful on fund flows

A weaker dollar will benefit countries and corporates that need to service debts denominated in the USD. Once rates reverse course, USD debt issuers will see a reduction in their debt service burden. This, in turn, may encourage governments and companies to step up borrowing to finance infrastructure projects or business expansions, among others. Increasing investments buoy economic growth, which will benefit the outlook of Asian emerging markets amid a softening US dollar.

In addition to reducing interest costs, Asian nations may see their external debt burdens alleviated as markets with strong currencies will attract funds chasing higher returns. Fund flows may prove to be positive for Asian emerging market equities and bonds this year. Taking 2017 as reference, the year when the USD suffered its worst performance in 14 years, emerging markets equities surged about 33% over the same period. Also, a weak dollar could benefit commodities-exporting countries.

It is worth noting that 2024 is a major election year with citizens of various countries heading to the polls. Together with the Israel-Hamas war, the US dollar could see some support given investors will want to park their funds at major currencies to control risks amid rising uncertainties. But in the short term, we believe the USD weakness will linger.

For investors who are interested in Asian assets, it is sensible to stay on the lookout for fund flow trends and consider jumping on the Asian emerging markets bandwagon as the dollar strength reverses.