[Seoul = NewsPim] Reporter Oh Sang-yong = The US-Iran Memorandum of Understanding (MOU) to end the war can partially relieve the downward pressure on Asian currencies, especially those of net energy importers. However, the speed, extent, and sustainability of the rebound in Asian currencies may be frequently constrained by the pace of oil price declines, US monetary policy, and various variables that may arise in the second phase of US-Iran negotiations (nuclear negotiations).
1. A Moment of Relief?
As of the first quarter of last year, 89% of Middle Eastern oil passing through the Strait of Hormuz headed to Asia. Among them, China accounted for 38%, followed by India (15%), South Korea (12%), and Japan (11%). The outbreak of the US-Iran war on February 28 caused the Strait of Hormuz to be blocked, and the damage was concentrated on these Asian countries.
This acted as pressure to lower the value of the currencies of these net energy importers in the foreign exchange market. Not only the Korean won (KRW) and Japanese yen (JPY), but also the Indian rupee (INR) and Indonesian rupiah (IDR) experienced significant fluctuations.
The US dollar, on the other side, faced dual upward pressure. The relative advantage of being an oil exporter was highlighted, and the inflation driven by oil prices extinguished expectations of a Federal Reserve (Fed) rate cut, even fueling expectations of a rate hike within the year.
[Image: Trends of USD/KRW, USD/JPY, USD/IDR, USD/INR over the past 6 months (Source: koyfin)]
As can be seen in the chart below, US crude oil exports have shown a sharp increase since the outbreak of the Iran war. This is because Asian countries that had difficulty importing Middle Eastern oil shifted their import sources to the US. Naturally, the movement of dollars from these countries to the US increased, which appeared in the foreign exchange market as increased dollar demand from Asian refiners.
The signing of the US-Iran MOU means the opening of the Strait of Hormuz within 30 days and the lifting of the US blockade of the Iranian strait. When the supply of Middle Eastern natural gas and crude oil, which had been stranded, resumes, the geopolitical discount that had been applied to Asian currencies via oil prices will also decrease. Additionally, historically, a reduction in geopolitical risk often leads to a reversal of safe-haven currency preferences, i.e., a weakening of the dollar.
[Image: US daily average crude oil export (4-week average) trend (Source: US Energy Information Administration)]
However, given that oil prices have been notably declining since last week in reflection of the possibility of a US-Iran agreement, this factor may have been partially priced into the foreign exchange market. Moreover, the US and Iran face a bigger challenge ahead: nuclear negotiations. There is no guarantee that the process will go smoothly, and Iran's Revolutionary Guard has no intention of giving up its external deterrence (control of the Strait of Hormuz). The risk of conflict in the Middle East has not completely disappeared but rather remains a potential for normalization.
2. Forces Limiting Asian Currency Rebound: Structural Gravity
Exchange rates are a relative game. The retreat of Middle East risk reduces further depreciation pressure on Asian currencies, but for a meaningful and sustained rebound, the dollar's strength must fade. If oil prices continue to decline significantly, the possibility of a Fed rate hike this year may recede. However, even if energy prices fall, if they remain at elevated levels compared to before the Iran war for a long time, the timing of the Fed's rate cut may be delayed, or the rate cut cycle could even end.
This is especially the case if there is active movement to compensate for the increased cost of living due to higher oil prices through wage increases. This represents a second-round effect that pushes up the underlying pressure on US prices. In such a situation, it is difficult for the dollar to weaken.
[Image: The PCE price index and core PCE price index, which the Fed uses as a monetary policy benchmark, have been turning upward since the second half of last year, moving further away from the Fed's 2% target. (Source: Federal Reserve)]
The US unemployment rate remained stable at 4.3% for three consecutive months even during the Iran war. The US economic growth rate (GDP growth) is still robust due to investment vitality based on the artificial intelligence (AI) boom. The US labor market environment of 'neither significantly increasing nor massively laying off' and growth reliant on capital expenditure (fixed asset investment) reduce the justification for the Fed to cut rates hurriedly. Instead, the Fed is likely to maintain a cautious stance for the time being, confirming that the inflationary pressure that rebounded due to the Middle East war has eased again.
At this week's Federal Open Market Committee (FOMC) meeting, language indicating the Fed's further rate cut bias may disappear from the statement. It will also be a point of interest how much new Fed Chair Kevin Warsh can temper the hawkish views of his fellow policymakers.
[Image: US unemployment rate and Fed policy rate trend (Source: Federal Reserve)]
If oil prices continue to fall, expected inflation may also decline, leading to lower nominal bond yields (Treasury yields). However, a notable point is the recent steady rise in US real interest rates. The yield on the 10-year Treasury Inflation-Protected Securities (TIPS), used as a proxy for real interest rates in the bond market, has risen from 1.70% just before the outbreak of the Iran war to around 2.2% recently.
This is against the backdrop of a still robust US economy, fading expectations of a Fed rate cut and rising prospects of a rate hike, increased fiscal burden due to the Iran war and the resulting possibility of increased Treasury supply, and private savings absorbed by US AI investment. The dollar index (DXY) has moved almost in tandem with US real interest rates.
While the retreat of Middle East risk creates a favorable environment for assets denominated in emerging market currencies including Asia, the US economy, which is uniquely ahead in AI, and the AI flagship stars (OpenAI, Anthropic) awaiting their NYSE debut will continue to be a gravitational field attracting global capital toward US assets. The opening of the Strait of Hormuz does not eliminate the structural dollar strength factors.
[Image: US real interest rate (blue, 10-year TIPS yield) and dollar index (purple) trend (Source: koyfin)]
Moreover, President Donald Trump, who sealed the Iran war, is likely to devote all his energy to the midterm elections until this fall, and is likely to increase pressure on neighboring countries and foreign companies to accelerate promised US investments. While not a new factor, trump's escalating pressure weighs on non-dollar currencies.
3. 'Don't Miss the Turnaround Opportunity'
At this point, it is worth noting the recent movement of the Japanese yen, one of the countries directly hit by the oil price shock from the Iran war. Last week, despite the prospect of a US-Iran MOU and the possibility of a Bank of Japan (BOJ) rate hike, the dollar/yen exchange rate could not fall below the 160 level - the downward pressure on the yen did not significantly ease.
In the Tokyo foreign exchange market, there are still observations that if the Fed eventually pivots to a rate hike, the effect of the BOJ's rate hike on the yen's rebound will be halved.
Regarding this, Hideo Kumano, chief economist at Dai-ichi Life Research Institute, suggested that the BOJ needs to take preemptive action to change market perceptions. He said, "Currently, market participants think that the BOJ's rate hikes will happen about once every six months. Overturning that expectation would help correct the yen's weakness." He mentioned that signaling at a press conference after the BOJ policy meeting that "there could be one to two more rate hikes among the four remaining policy meetings this year - that is, not only in December but also in July, September, or October," would constitute such a preemptive strike.
He also emphasized that "for foreign exchange intervention to be effective, it must be executed boldly when the currency value deviates excessively from fundamentals, and especially when a turning point is given." Kumano said that the signing of the US-Iran MOU to end the war "corresponds to such a timing." In July 2024, the BOJ's rate hike and the authorities' currency intervention occurred simultaneously. He added, "Using both tools simultaneously again this time could help enhance the effect of correcting the yen's weakness."
This is advice worth noting for other Asian central banks that are suffering from exchange rate woes by failing to raise benchmark rates in a timely manner and procrastinating on their homework.
[Image: Major currencies (Photo = Reuters)]
