Fed Likely to Hold Sway

The most important issue here is likely to be the changing policy stance at the US Federal Reserve. To some, it might appear as though central bank policy in the United States would have limited influence over currency markets in Asia. But if we see any significant surprises here, we can expect renewed volatility in most of the world’s currencies.

In the chart above, we can see that broad strengthen in the US dollar has gradually increased throughout the year. This has come mostly as a result of the changing expectations the market sees with respect to where interest rate policy is likely headed in 2016. The Dollar Index is still pressuring its highs near 12,200, and at this stage there is little reason to believe that these highs will be broken in the next few months.

Any suggestion that the Fed is ready to start raising interest rates would be a clear catalyst for such a move. Higher interest rates in the US would suggest that consumer spending in the country would slow -- and this would be a negative for Asian export markets in countries like China and Indonesia.

Higher interest rates would also be a positive for the US currency, and this would require currencies on other regions to be sold more heavily in order to fund those moves. In this way, it would seem that the fate of the main Asian currencies rests on decisions that are likely to be made in other areas of the world.

Of course, there is no guarantee these monetary policy changes will actually take place. There was a large percentage of the market that expected the same changes in 2015 -- and they did not come to fruition. But it can be argued that these policy changes are only a matter of time, and if they do occur next year we will likely see lower valuations in assets like the Indonesian rupiah.

This column was written by Richard Cox, university teacher in international trade and finance, focusing on lessons in macroeconomics and price behavior in equity markets.