Understanding the big moves in Asia FX

What We Think

• The extreme movement in the Taiwanese dollar (TWD) can be attributed to a combination of FX conversion by exporters, a repatriation of fixed income investments, and local life insurers increasing their hedging ratios.
• With the broader backdrop of USD weakness, CNH could continue to remain largely stable against the dollar, while weakening against a basket of currencies. Such an outlook still supports using CNH as a funding currency.
• The HKMA intervened in markets to defend the USDHKD peg, and we see the peg remaining “safe” given that the ratio of foreign reserves held by the HKMA against Hong Kong's currency has consistently remained comfortably above 100%.

Investment Implications

• As markets continue to grapple with tariff-related uncertainty, growth and inflation fears, plus longer-term concerns over the trajectory of U.S. assets and the U.S. dollar, diversification will likely remain a key theme for investors.
• Even though we still see U.S. assets and the dollar as core allocations to portfolios, global diversification can help moderate currency risks and diversify sources of returns in your portfolio.

Amid broad market volatility in the last few weeks, a particular area of focus has been the currency market. U.S. dollar weakness, while initially concentrated in traditional ‘safe haven’, low-yielding currencies like the CHF and JPY, has been broadening out across other currencies, and some individual pairs have seen unusual, and even extreme moves such as the Taiwanese dollar (TWD). Growing numbers of investors are concerned about whether ‘U.S. exceptionalism’ – which has characterized much of the outperformance in U.S. assets (particularly equities and the dollar) – is over, and whether it is time to allocate away from the dollar and dollar assets.

In this note, we analyze the reasons for the moves in some Asian currencies and consider the implications for their respective economies and markets. We also reiterate our recommendation for dollar diversification.

What’s behind the historic move in the TWD?

The Taiwanese dollar (TWD), historically known for its low volatility, has appreciated against the USD by approximately 9% since the end of last week, marking its largest surge since the 1980s.

Why it’s not clear what caused the abrupt move, especially the timing, is that it appears this movement can be attributed to a local life insurers rapidly hedging USD exposure and to a lesser extent FX conversion by exporters and repatriation of fixed income investments. Such pronounced volatility is extremely rare for the TWD, given that the currency is highly managed by the Taiwanese central bank (CBC). The effects of these movements have reverberated throughout the Asia FX market.

Why could Taiwanese life insurers be behind the move in the TWD? For context, Taiwan runs one of the largest current account surpluses in the world. Over time, instead of the central bank accumulating these excess foreign currency earnings as reserves, life insurance companies were allowed to grow their FX assets as a means to continue growing their business. After all, the supply of domestic bonds is limited, making it difficult for Taiwanese insurers to grow. By issuing policies locally in TWD and investing the assets overseas into higher-yielding USD bonds, with only partial hedging of those positions, Taiwanese life insurance companies were able to profit off the rate differential…as long as the TWD doesn’t appreciate.

To put numbers around it, Taiwanese lifers have over USD 700 billion invested overseas, mostly in fixed income, with about 30% unhedged or not backed by USD-denominated policies. This amounts to roughly 110% of Taiwan’s GDP. Closing that gap would lead to USD 150-200 billion USD worth of TWD buying, which the currency market can hardly absorb. So back to what caused the TWD move – with dollar depreciation following ‘Liberation Day’ tariffs beginning to accelerate and broaden, it’s likely that insurance companies were increasingly worried about the currency mismatch and stepped in to start hedging more aggressively. 

Given that hedging costs have increased significantly, we anticipate that hedging activities by Taiwanese lifers could moderate in the short term. However, the ongoing foreign asset accumulation and associated currency mismatches may require a more sustainable solution, especially if the USD continues to depreciate. To be clear, the central bank could step in at any time to weaken the TWD and prevent further impact to Taiwanese insurers running an asset/liability currency mismatch. Here, tariff negotiations will likely be key to watch moving forward.

Taiwan’s currency is heavily managed and Taiwan has been named as a currency manipulator in the past. Stepping in now to depreciate the currency could be taken negatively by U.S. authorities as they kick off trade negotiations. Notably, there is little indication of the CBC taking action to stabilize the market this time, possibly due to the sensitivity of currency interventions during trade negotiations. However, if there’s another large squeeze forcing lifers to hedge more, the CBC could eventually step in to stabilize the market.

The extreme moves in the TWD underscores the importance of USD diversification in portfolios, especially for those heavily concentrated in USD assets (our analysis indicates that our clients hold over 90% of their assets in USD denomination or equivalents). If global asset repatriation and USD hedging becomes a lasting trend, it could potentially lead to the gradual unwinding of the 10-20% overvaluation of the greenback compared to its long-term fair value.

Could the CNH strengthen in a weak USD environment?

There are more debates about the Chinese yuan’s outlook due to several recent developments. The USD has weakened by 8% year-to-date and could be poised to decline further if policy uncertainties persist. On the trade front, China and the U.S. are set to begin talks this weekend, with Treasury Secretary Scott Bessent and Trade Representative Jamieson Greer meeting a delegation led by Vice Premier He Lifeng. Additionally, China is ramping up monetary easing by adjusting the 7-day reverse repo and lowering the reserve requirement ratio (RRR).

While the initiation of trade talks is a positive sign, and we believe both sides are willing to partially reduce the tariff rate from the current 100%+ levels, the likelihood of a dramatic reduction remains low. This means tariffs could continue to make trade between the two countries prohibitively expensive. We expect China’s exports to decline by around 10% from last year, requiring significant policy support from Beijing to cushion the impact (considering exports have been the main contributor to Chinese growth in recent quarters).

Economic growth differentials are a major driver of CNH’s fair value. The growth impact from U.S. tariffs, as well as a potential global trade downturn, could still be significant despite policy support. Additionally, as Beijing focuses more on utilizing domestic policy easing to address external shocks, FX policy may coordinate with broader policy objectives, suggesting that the People’s Bank of China (PBOC) may be unlikely to tolerate a significantly stronger yuan.

Over the past week, USDCNH was caught in the TWD spillover, briefly dipping below 7.20 amid low liquidity during the Labor Day holiday. However, the move has been significantly smaller than that of other Asia FX peers, with the exception of pegged currencies. In fact, over the past month since the Liberation Day, volatility in the FX market has increased significantly, with double-digit swings seen in several G10 currencies, while the CNH has remained largely stable. This again demonstrates its low volatility characteristic. With the broader backdrop of USD weakness, CNH could continue to remain largely stable against the dollar, while weakening against a basket of currencies. Such an outlook still supports using CNH as a funding currency.

What’s happening with HKD and the peg?

As Asia FX rallied against the dollar, the Hong Kong Monetary Authority (HKMA) intervened by selling a record HKD 60.5 billion to curb the currency's appreciation. This was followed by an additional HKD 12.8 billion sale, aimed at keeping USDHKD movements within the 7.75-7.85 trading band established by the currency peg regime. This substantial liquidity injection reduced the currency’s funding costs across the curve, resulting in a wider interest rate differential against the USD.

Such intervention efforts demonstrate the effectiveness of Hong Kong’s exchange rate pegging mechanism. The reduction in funding costs could also offer some secondary support to the local economy amid the negative growth impact of U.S. tariffs, although this was not the reason for the intervention.

The exchange rate mechanism that pegs the HKD to the USD operates through a "currency board" system. The key features of this system include the requirement for the HKMA to align with U.S. monetary policy and to maintain foreign exchange reserves that are equal to or greater than the existing money supply. Consequently, under a well-managed system, every HKD banknote should be exchangeable for USD. Additionally, the HKMA is restricted from setting discretionary monetary policy.

For strong evidence that the peg is "safe" from market-driven shocks, the chart below shows the ratio of foreign reserves held by the HKMA designated to defend the peg – known as the backing assets – against Hong Kong's monetary base. The backing ratio has consistently remained comfortably above 100%.

Investment implications

As markets continue to grapple with tariff-related uncertainty, growth and inflation fears, plus longer-term concerns over the trajectory of U.S. assets and the U.S. dollar, diversification will likely remain a key theme for investors. We still see U.S. assets and the dollar as core allocations for most investors, but global diversification can help moderate currency risks and diversify sources of returns in your portfolio. We have deep-dived into those topics here and here.