Gyrations of the USD tend to destabilize the world economy and financial markets. USD strength, as seen in H1 2018, can put severe strain on economies that require cheap dollar funding. Any significant weakness in the USD will put pressure on export champions, such as Germany and Japan. It will also raise the specter of inflation as commodity prices tend to rise sharply in response to a weak USD. The best of all worlds is a fairly stable USD. With Fed tightening being well advanced and the European Central Bank as well as the Bank of Japan gradually catching up, chances are good that the USD will indeed be stable.
A broadly stable USD against the majors should provide a platform for Asian currencies to find a firmer footing, especially if there is improved clarity on the trade tensions between the USA and China. A stronger EUR would also allow both the CNY and the SGD to appreciate against the USD without rising too much against their respective trade-weighted baskets, which are important barometers for both Chinese and Singaporean policymakers.
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China’s resilience
The US trade policy is putting considerable strain on China. Moreover, after the USA recently renegotiated trade agreements with Mexico, Canada, and South Korea, and amid de-escalating trade tensions with Europe, the US trade stance toward China could harden further. China’s patience is thus likely to be additionally tested. If its policymakers proceed cautiously, as in 2018, risks of instability should be limited and the expansion can be extended. However, any aggressive currency policy, credit easing, or foreign policy would be destabilizing.
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