What is Asia most afraid of in the "currency defense war"? The Federal Reserve has postponed its interest rate cut until next year, and oil prices have risen by more than $110!

The US dollar rose for the fifth consecutive day as the Fed's interest rate cut expectations fell again and again, and the safe-haven demand soared due to changes in the Middle East, and emerging markets once again launched a "currency war", and the bigger risks seem to be over yet.

On April 15, a team led by Chetan Ahya, chief economist at Morgan Stanley Asia, released a report saying that inflation in most Asian economies has fallen to create conditions for central banks to cut interest rates, but emerging market central banks do not dare to "act rashly" due to the pressure of currency depreciation.

If most countries in Asia keep interest rates high for a long time, this will put the economy under more pressure. Morgan Stanley stressed that if the Fed delays cutting interest rates until 2025, or if oil prices rise sharply to $110-120 a barrel, Asian countries will be "forced" to postpone interest rate cuts, putting pressure on economic growth.

Since April 10, the dollar index has accelerated significantly, breaking through the 105 and 106 mark, and yesterday's US retail sales data for March exceeded expectations, showing that the economy is still resilient and boosting the dollar again. As of press time, the dollar edged higher to 106.31.

The dollar's recent rally has also put emerging markets in a "currency war" and put pressure on a growing number of emerging economies to intervene. According to the data, the MSCI Emerging Markets Currency Index fell for the fifth consecutive day, approaching the low level of the year.

Asian central banks dare not "act rashly" due to the pressure of currency depreciation

Morgan Stanley believes that about 80% of Asian economies have inflation rates at or below the target range of central banks, and the gap between the inflation level of the remaining Asian economies and the target range of central banks is also narrowing, indicating that the central bank's CPI target is just around the corner:

Core goods and services inflation is slowing, which is contributing to a slowdown in headline inflation. Core inflation in Asia, which is more driven by the goods component (which in turn reflects higher input costs), has now fallen back to pre-COVID levels.

For services inflation, labour market trends are key, with the exception of Australia, where the labour market appears to be largely balanced.

Real interest rates in the region have risen to five-year highs as Asia returns to its pre-pandemic low inflation environment, the report said. The real interest rate, based on the 12-month forward CPI, has reached 1.7%, slightly higher than the pre-pandemic five-year average of 1.5%:

However, as the market gradually lowers expectations for the Fed to cut interest rates, the dollar strengthens, while Asian currencies remain weak, Morgan Stanley believes that central banks may remain cautious about cutting interest rates, and will follow the Fed If the currency depreciates further, it may put upward pressure on inflation, making it difficult to maintain inflation within the target range. As a result, Asian central banks will wait for the Fed to start cutting interest rates in June (the baseline scenario for the US economic team) before acting.

Morgan Stanley does not expect real interest rates to rise in Asia for long on the backdrop of the Fed's first rate cut in June, but if the nominal policy rate remains high for longer, it will put pressure on Asian economies.

Downward pressure on the economies of Asian countries

Morgan Stanley noted that if Asian central banks are able to cut interest rates from June or May, the improvement in exports and capital spending is expected to mitigate the risk of slowing economic growth, and the key risks now are that the Fed may delay rate cuts until 2025 and supply concerns should push oil prices to $110-$120/bbl.

According to Morgan Stanley, the policy stance of Asian central banks will largely depend on the actions of the Fed. If the Fed delays the rate cut, the rate cut cycle in Asian countries will also be delayed accordingly, which also means that Asian economic growth will slow slightly, and it is important to understand the motivation of the Fed to delay the rate cut, if the Fed delays the rate cut because of the upside risk of inflation due to tight supply, then this will have a clear negative impact on the Asian economy:

Asian economies may also benefit if the Fed delays rate cuts because the US economy continues to maintain strong GDP and employment growth against the backdrop of improved supply, such as increased labor supply. A stronger U.S. economy is likely to bring more Asian exports and have a positive spillover effect on investment. Overall, there are still modest downside risks to the growth outlook.

If the Fed delays cutting interest rates because of the upside risk to inflation due to tight supply, then this will be a clear negative impact on the Asian economy. In this case, Asia's economic growth will face greater downward pressure. Central banks in countries such as India, Indonesia, South Korea, the Philippines and Thailand may have to postpone rate cuts.

The report notes that if oil prices continue to rise to $110-120/b over the next 3-4 months due to supply or geopolitical concerns, this will raise concerns about the inflation outlook. Against this backdrop, Asian central banks are likely to delay rate cuts against the backdrop of higher energy prices that will lead to increased headline inflationary pressures and could pose upside risks to the inflation outlook:

Historically, Asian central banks have focused more on the impact of higher energy prices on inflation than on demand. Against this backdrop, Asian central banks are likely to delay rate cuts. Supply shocks and central banks' inability to cut interest rates will further dampen aggregate demand.

Most economies in Asia are net importers of oil, so they will be affected by higher oil prices. Among them, Thailand, South Korea, the Philippines and India will be more affected by the CPI being more sensitive to rising oil prices and their oil trade deficits being larger.

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