The refrain from many market participants as yields continue to rise is that ‘something is going to break’.
A good bet for something that will run into trouble is Asian FX, emerging markets in particular. Indonesia surprised markets by boosting interest rates to 6% today despite a slowing economy.
The suspicion is that they’re trying to stem capital outflows and support the rupiah. Those flows become more and more tempting with US 10-year notes paying nearly 5%.
USDIDR weekly
“The global dynamic is very fast. We need to review again from month to month. Our goal is the same: Price stability, financial system stability and payment system stability to support our economic growth,” Governor Perry Warjiyo said.
The problem for Indonesia — and much of the emerging world — is that if the global economy and domestic economies slow, but the US stays strong and the Fed keeps rates high, it could result in spiralling currency losses. This is particularly problematic in countries with large current account deficits or heavy USD-borrowing.
Indonesia and others are using FX reserves to fund intervention but they may be selling Treasuries to fund the moves. That’s fine if it’s only a few countries doing it but as it gets more widespread, it can spiral.
It’s factors like this why I believe the US dollar is headed for a material overshoot before the end of this cycle.