The price of gold has reached a peak at a time of maximum peril for the US dollar, causing new bouts of PTSD for the Asia region. The real problem is a trifecta of concerns that are moving to center stage, setting Asia up for a rough 2024. The US Fed’s most aggressive tightening since the mid-1990s, fiscal concerns, and political polarization in Washington are putting the world’s largest economy’s last AAA credit rating at risk.
The dollar reaching its peak is somewhat of a relief, as it is compounding the pressures on many emerging markets due to the $46 billion of rated dollar-denominated debt coming due next year, excluding China. Periods of extreme dollar strength don’t tend to favor Asia’s export-reliant economies, as powerful dollar rallies have hoovered up disproportionate amounts of capital, depriving Asia of needed investment.
The 1994-1995 period, the last time the Fed tightened as aggressively as it has over the last two years, was the real bookend for Asia. At the time, the Fed doubled short-term interest rates in just 12 months, and by 1997, a multi-year dollar rally and rising US yields made currency pegs impossible to maintain. This led to Thailand’s chaos-generating devaluation in July 1997, Indonesia and South Korea scrapping their dollar pegs, the Philippines and Malaysia to the brink, and global investors worrying Japan and China might also tumble. Asia faces a significant risk due to markets losing faith in the dollar, as Moody’s Investors Service threatened to downgrade the US, potentially causing the loss of its last AAA rating.
This threat may overshadow any relief from the Fed’s reluctance to impose rate hikes. Moody’s analysts predict that the US’s fiscal deficits will remain large, significantly weakening debt affordability, despite higher interest rates and effective fiscal policy measures. Washington disagrees with this shift, stating that the American economy remains strong and Treasury securities are the world’s preeminent safe and liquid asset.
However, global central banks, including Asia’s 10 largest currency reserve-hoarding institutions, hold more than $3.2 trillion of US Treasuries, with Tokyo being the largest with $1.1 trillion of exposure. Beijing’s banker, Washington’s No. 2, is reducing dollar exposure amid a 40% decrease in US government debt, while a gold rally has pushed spot prices above $2,100 for the first time.
Gold’s attractiveness has been boosted by the expectations of the end of the tightening cycle, pushing longer-term yields lower. However, the global economy is now facing the most dangerous set of risks in several decades, with top US bankers like JPMorgan Chase CEO Jamie Dimon warning. The geopolitical risk environment has changed, with concerns about Russia’s invasion of Ukraine, Israel and Gaza, trade tensions between the US and China, and the South China Sea and China’s actions in Taiwan. Investor demand for safe-haven assets like gold has increased due to the shaky global economic backdrop and the Israel-Hamas conflict.
Expectations for Fed rate cuts next year have pushed the US dollar downward, increasing gold’s appeal. However, Goldman Sachs economists view the monetary easing as excessive. Deutsche Bank detailed six episodes over the last two years when markets decided the Fed’s rate hike cycle was ending but continued, including the Omicron variant scare in November 2021, Russia’s Ukraine invasion in February 2022, China’s pandemic lockdowns, global recession fears in July 2022, England’s debt chaos in autumn 2022, and Silicon Valley Bank’s collapse in March 2023.
Deutsche Bank suggests that the risk of over-tightening and policy risks being too restrictive is increasing as inflation begins to fall. The rise in unemployment and falling inflation may push the Fed closer to cutting rates in previous cycles, but 2023 has shown how expectations for cuts have been repeatedly pushed into the future. Other potential risks include the Israel-Hamas crisis leading to a broader Middle East conflict, Saudi Arabia’s push to reduce OPEC+ production, and Russian leader Vladimir Putin intensifying his military campaign in Ukraine, which could boost energy and food costs.
US-China trade tensions may worsen in ways that inflame inflation, with political brawls ahead of the November 2024 election potentially leading to additional sanctions on China that upend supply chains and boost global inflation. The dollar is expected to recover into year-end due to its high yield in the G-10 and higher-yielding markets. ANZ Bank analysts predict a hawkish Fed policy stance, while gold’s bull run and cryptocurrencies suggest America’s finances and political tribalism are the bigger concern.
At the end of October, the US government’s estimated annualized debt interest payments topped $1 trillion, doubling the government’s payments burden over just the last 19 months. Bloomberg Intelligence analysts argue that the challenge for the government is tempering mandatory spending and trying to reduce the need to issue more debt. If yields continue to surge, fiscal pressures will reverberate through the halls of power in Washington and make for high drama every time the Treasury Department holds a debt auction, especially for Asia’s central banks and finance ministries.
US political polarization is causing concerns about the dollar’s credibility in 2024. Fitch Ratings’ August 1 move to downgrade the US to AA+ from AAA has sparked global markets to focus on the deficit issue. Ed Yardeni, president of Yardeni Research, notes that if inflation remains “sticky,” the US Treasury Department could have a “bond vigilantes” problem, prompting politicians to do more fundamental measures to reduce the deficit. However, extreme polarization in Washington makes this highly unlikely. The Biden-Trump tussles have already run afoul of currency traders, with some of Biden’s policies running afoul of currency traders.
The specter of a Trump 2.0 presidency presents risks, including the likelihood of escalating trade wars with China and beyond. Trump’s team mulled canceling portions of US debt held by Beijing in his first term and browbeating the Fed into easing in 2019, denting Powell’s reputation for independence. China’s efforts to internationalize the yuan in the Xi era also suggest that the dollar’s credibility troubles have only just begun, as indicated by the rallies underway in gold and Bitcoin.
