US Dollar: North Asia FX misalignment risks – BNY

BNY’s Geoff Yu notes that the US Dollar has strengthened more against a North Asia import-weighted basket than against traditional currencies, raising concerns for US inflation. He highlights that CNY, JPY, TWD and KRW have lagged fundamentals despite large trade surpluses with the U.S. Yu argues that this misalignment complicates balance-of-payments adjustment and could risk a US Dollar valuation overshoot.

North Asia currencies lag fundamentals

"Similar comments are applicable to all North Asian exporters. Despite running ever-higher surpluses against the U.S., the dollar appears to be trending back to the high end of its recent range against this group."

"This matters for U.S. inflation, too, since the U.S. runs trade deficits against all of them; weighted by their year-to-date U.S. import shares, the USD vs. North Asia basket (CNY, JPY, TWD and KRW) is up near 4% this year."

"In contrast, the broader dollar index, which reflects USD performance against traditional names, is also up 1%."

"There is a strong case for USD to outperform the latter group due to growth and policy differentials. However, in terms of balance-of-payments adjustments, North Asian exporter currencies are not reflecting the changes in their respective terms of trade"

"At the same time, we expect the U.S. to strengthen calls for those currencies to reflect “strong fundamentals” of the economies. Doing so would also help the Fed avoid a USD valuations overshoot, which would complicate monetary policy."