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A new analysis from one of the world's biggest banks finds the current bout of Dollar weakness has its roots in Asia.

HSBC finds a decision by Chinese authorities to substantially lower the Dollar-Yuan fix, and a washout in Yen positioning are the primary drivers of a broader Asia-FX rally.

"More often than not, developments in the US market set the tone for USD-Asia – for example, during the first half of November, when we had downside surprises in key US data – but, since last Friday, the tables have turned. Asian currencies are independently moving and weakening the broad USD," says Joey Chew, Head of Asia FX Research at HSBC.

Others are in agreement. "Amid the rally in 'risky' assets over the past week, gains in FX markets against the greenback have been led (somewhat surprisingly) by major currencies in Asia, notably the yen and renminbi," says Jonathan Petersen, Senior Markets Economist at Capital Economics.

HSBC's Chew says those betting against the Yen appear to have been caught out by the dollar selloff. This sector of the market is sizeable, with the most recent set of CFTC positioning data revealing short JPY contracts suddenly increased by 25% during the week ending 14 November, after over a month of little change.

In fact, the analyst notes the number of short JPY contracts as of 14 November exceeded that seen at the start of July 2023 and November 2022 and was, in fact, the most extreme since 2017. So, there are a lot more long USD-JPY positions to unwind than usual.

"Our simple regression models based on current yield differentials suggest that it would not be out of line for USD-JPY to be at 145-146," says Chew.

Authorities in China have meanwhile engineered substantial U.S. Dollar weakness: "After nearly two months of being in a tight 7.17-7.18 range, the fixing has been lowered by more than 300 pips in two days, to 7.1406 this morning," says Chew.

Above: The Dollar index, a measure of broad Dollar performance, measured at 30-minute intervals.

The HSBC analyst says if Chinese authorities allow the fixing to go lower than that this week, it could trigger a bigger washout of long USD positioning that should keep the broader Dollar under pressure.

He says the People's Bank of China may want to do this for the following reasons:

to reduce the imbalance between FX demand and supply that had caused FX volumes onshore to plunge in previous months;to drive home a message that the RMB is not on a trend depreciation path and thereby restore confidence among investors;to create a window of opportunity for monetary easing later.Meanwhile, the pressures against the Dollar are being replicated in other Asian names, such as the KRW, SGD, TWD and MYR, which are seeing outsized moves.

"The most important factor for the rally in the yen and renminbi is the ongoing fall in US yields. After all, US bond yields across the curve had been steadily rising and putting pressure on these currencies for much of this year," says Petersen.

He notes that bond yields in Japan and China have not kept pace with the US, either on the way up or the way down.

"So, it isn’t surprising to us that these currencies have rallied amid the fall in US yields since mid-October," says Petersen.

Looking ahead, Capital Economics things current moves can extend. "We expect bond yield gaps to remain a tailwind for the yen and renminbi as inflation in the US continues to moderate and investors discount more rate cuts from the Fed over the next couple of years."