More Pain Ahead for Euro, Yen, and Yuan

  • The US Dollar has spiked up against major currencies this year, including a 24% surge against the Japanese yen. 
  • The Federal Reserve’s rate hikes are a key factor lifting the dollar but there are others at play, too.  
  • Spiking energy prices and growth worries are contributing to weakness in the greenback’s rivals. 

The US dollar has been crushing many rivals this year including the Japanese yen, the euro, and the Chinese yuan, and foreign exchange market experts say the strength of greenback isn’t set to wane in the near-term.

The Federal Reserve is the marquee driver behind the dollar’s jump, with policy makers attacking hot inflation with large interest rate hikes to slow economic activity. The Fed’s fifth rate increase this year is expected on Wednesday, and will push the Fed funds rate up from its 2.25%-2.5% range. 

While the Fed is in the spotlight, investors’ views on an economy’s competitive strength can serve as a medium-term driver for currencies, said Marc Chandler, managing director at Bannockburn Global Forex. In that, shifts in the global trade environment and growth concerns are contributing to weakness among the dollar’s rivals. The US Dollar Index has climbed to 20-year highs and has gained 14% this year.

Here’s a look at what’s pressuring the yen, the euro, and the Chinese yuan.

 

Japanese yen


The yen has plunged a whopping 24% versus the greenback in 2022. The dollar recently pushed beyond 145 yen for the first time in 24 years. The yen trade has been “fascinating” with the Bank of Japan’s commitment to bond buying to keep its 10-year yield capped at 0.25%, Edward Moya, senior market analyst at Oanda, told Insider.

The BOJ since 2016 has been controlling its yield curve to increase inflation. With the Fed’s aggressive rate campaign, the US 10-year Treasury yield has soared close to 3.5%, making the bonds more attractive compared to Japan’s and weighing on the yen’s value.

“The Japanese economy has been struggling to trigger inflation … and now we’re possibly seeing inflation with wage growth that could make the Bank of Japan change policy at some point next year,” said Moya.

The BOJ’s next policy statement is due Thursday. Bank of America sees “no budging” on yield curve control despite global central banks (minus China’s) hiking interest rates. BofA expects the dollar to rise to 150 yen on “rate differentials, fears of debasement and capital flight.”

Meanwhile, the world’s third-largest economy is experiencing a negative terms-of-trade shock, said Chandler.

“Japan’s importing most of its food and energy. The price of food and energy has gone up a lot faster than [those of its] manufactured goods. So Japan, like Europe, has swung from trade surpluses to trade deficits,” he said, noting another factor hurting the yen.

Euro

The eurozone’s shared currency has lost 13% versus the dollar this year, tumbling below parity for the first time since 2002, with possibly further to fall. Barclays has a forecast of $0.9800 for both the fourth quarter of 2022 and the first quarter of 2023. It traded at $0.9950 on Friday.

Russia slashing gas flows into Europe has sent gas and electricity prices soaring and has forced the European Union to scramble to store gas before winter hits.

“The eurozone economy is so weak and with prices rising, this is causing an economic slowdown. People are struggling to make ends meet,” Fawad Razaqzada, market analyst at Forex.com, told Insider. “For businesses, it’s raised input costs in terms of energy. Sentiment towards the euro is quite weak although the [European Central Bank] is hiking interest rates because of their mandate to control prices.” Eurozone inflation in August hit a record high of 9.1%.

Europe’s energy crisis may not be fully priced into the euro until the winter season as that’s when it will become clearer if the region has enough energy supply or not, said Moya. “A lot of that will depend on the weather. Europe’s looking vulnerable … and that’s going to be tough for the euro over the rest of the year.”

Chinese yuan

The yuan this week dropped to a two-year low against the dollar, with the greenback crossing above 7 yuan per dollar. China’s currency has lost nearly 10% this year. The People’s Bank of China has worked on providing upside support in recent weeks in part by fixing the currency’s daily rate above market expectations as it prepares for the next Fed rate hike.

Economic data on Friday included August retail sales and industrial production that beat expectations, but the yuan fell.

“The Chinese economy is struggling, make no mistake about it,” said Razaqzada. “Its zero-COVID policy weakens momentum that the economy gets in terms of growth. As long as the policy stays in place, it’s very difficult to see a way out for yuan.” He sees the greenback soon running higher to 7.20 per yuan.

Friday’s data also showed sales and prices falling in China’s property sector, an important growth engine for the world’s second-largest economy.

“Its cash register has broken down,” Chandler said about the property market ahead of data. “What’s the next developmental model and how can you minimize the damage?,” are questions China needs to address, he said.