Asian currencies that will benefit the most from the Fed’s rate cuts

The U.S. Federal Reserve is expected to cut interest rates later this year and, while that may not be good news for the dollar, some Asian currencies stand to benefit.

Higher interest rates boost a country’s currency, attracting foreign investment and increasing demand for the country’s currency. A weak U.S. dollar is generally positive for emerging markets, which is often the case when the Fed cuts interest rates outside of an economic crisis.

The Fed shifted to a more dovish stance in December, with markets now pricing in rate cuts by summer. The CME FedWatch tool suggested the first 25-basis-point rate cut in 2024 could happen as early as June.

The Fed’s January meeting concluded with the central bank holding its benchmark borrowing rate in a range between 5.25% and 5.5%.

Experts told CNBC currencies such as the Chinese yuan, the Korean won and the Indian rupee stand to benefit from the Fed loosening monetary policy.

China has weathered a slew of disappointing headlines that have beaten down investor confidence. But hopes that authorities would not allow the trade-reliant nation’s currency to weaken below a certain level have limited yuan pessimism.

China has tried to stabilize the yuan against the dollar in the past and is expected to continue doing so, according to Arun Bharath, chief investment officer at Bel Air Investment Advisors.

“While the exchange rate has weakened to a 7 handle on the USD/CNY rate, reflecting a weaker economic situation in China, further weakening is unlikely as policymakers start to be more aggressive in fiscal stimulus, credit growth, and propping up property values,” Bharath said.

He noted that the Chinese currency’s exchange rate will likely hover in “a narrow band around the current exchange rate of 7.10.”

Unlike other major currencies like the Japanese yen or U.S. dollar which have free floating exchange rates, China keeps strict control of the onshore yuan. The currency is pegged with a so-called daily midpoint fix to the greenback based on the yuan’s previous closing level and quotations taken from inter-bank dealers.

Last year, the onshore yuan hit a 16-year low against the dollar at 7.2981.

If the Fed starts cutting rates by summer, that would likely narrow the yield differentials between the world’s two largest economies and alleviate some pressure off the Chinese yuan. Yield differentials is a way to compare bonds through the differences between how much they yield.

The People’s Bank of China is a main player in managing the currency, which Simon Harvey​​​​, head of FX analysis at Monex, said can be done through its daily fixing, liquidity measures, regulatory channels, and instructing state banks to intervene.

That last method is the most opaque as the total value of dollars in China’s FX reserves is unknown.

The Indian rupee could benefit from carry trades this year, a strategy where traders borrow low-yielding currencies such as the U.S. dollar in order to buy high-yielding assets like bonds.

“A lot of carry trade against other currencies like the yen or the euro but once interest rates fall in the U.S., we will see the interest rate differential widen to allow carry trade to happen. So those are also positive for the Indian currency,” said Anindya Banerjee, vice president of currency and derivatives research at Kotak Securities.

The rupee could also strengthen amid hopes the Reserve Bank of India may loosen monetary policy more slowly than other central banks.

Banerjee noted that the RBI’s rate cut pace will be “far slower” than the Fed and “will always significantly lag the Fed because India did not have the same inflation problem which Europe or America had.”

“The reason is simple, because fiscal policy is firing on all cylinders, the economy’s doing very well and they don’t want any overheating at this point in time,” Banerjee said.

The rupee has strengthened to as much as 82.82 against the dollar in the last three months. The currency dipped 0.6% in 2023, a much smaller weakening against the dollar compared to the prior year’s 11% decline.

South Korea’s won has been under pressure for three years, but improving economic prospects and looser Fed policy will help ease that strain in 2024.

“As a low yielding and highly cyclical currency, we think the Korean won stands to be one of the major beneficiaries of the Fed’s easing cycle in the second half of the year as lower U.S. rates will not only reduce pressure on KRW through the rates channel but will also lead to an uptick in the global growth outlook,” Monex’s Harvey said.

But Harvey said the won’s gains will also be determined by the extent of the Fed’s cuts. He predicted the currency could gain anywhere between 5% and 10% if the easing cycle is deep, while as little as 3% if the cycle proves to be shallow.

South Korea’s economic prospects are also expected to improve this year. The International Monetary Fund predicted 2.3% growth in 2024 and 2025, higher than last year’s growth of 1.4%.