TOKYO — Kevin Warsh’s arrival at Federal Reserve headquarters isn’t playing out the way Asia hoped.
Since taking the baton from Jerome Powell on May 22, Governor Warsh has run notably more hawkish than US President Donald Trump wanted — or at least so far. He could still be biding his time before doing the president’s bidding. But with US inflation running at 4.2% and the labor market holding up far better than expected, Warsh faces a complicated inheritance.
The Fed isn’t a dictatorship: when nine of 19 policymakers are already projecting a rate hike this year, any dovish pivot would trigger serious pushback from officials and bond markets alike. Long-term yields could surge if traders sense a MAGAified Fed is becoming reality.
Deutsche Bank’s economists now pencil in two 25-basis-point hikes after what they called a “hawkish” shift in style from the new chair.
That’s a remarkable about-face — and it’s reshuffling Asia’s calculus at bewildering speed. Currencies across the region are on the brink, from the yen to the rupee to the rupiah, with the Philippine peso and Thai baht joining the rout.
The common thread is a muscular dollar that’s punishing exchange rates almost across the board, keeping governments from Tokyo to Jakarta on daily intervention watch. Iran war uncertainty is adding fuel, sending the dollar higher and bringing out its wrecking-ball tendencies.
With US debt near US$40 trillion, inflation elevated, and Trump’s tariffs, spending binges and Middle East war all in the mix, the dollar is rising anyway — defying gravity, outpacing gold and Bitcoin, even overpowering the AI trade.
“The dollar is king while this conflict lasts,” says Carol Kong, economist at Commonwealth Bank of Australia. “If we’re right about this conflict being protracted, oil prices will just keep rising and it will push the dollar higher, at the expense of net energy importers like the Japanese yen and the euro.”
ANZ Bank analysts warn that “many questions remain on how the interim US-Iran deal will be implemented,” with vessel safety still a live concern and doubt about whether the chokepoint for a fifth of global supply will stay toll-free.
That uncertainty is pulling Tokyo back into a currency tug-of-war. The yen is down just 3% year-to-date, but it has traded past the psychologically charged 160 level — its weakest since July 2024.
It now sits inches from 161.96, which would mark the lowest since 1986. A breach there could make a slide to 170 look inevitable, and revive speculation about a freefall to 200 — a scenario Monex Group’s Jesper Koll has said isn’t out of the question, even up to 220.
All of this is tightening the vise on Prime Minister Sanae Takaichi. Since October, her government has staked its economic strategy on three pillars: a weak yen, ultra-low rates and fiscal loosening. That was a risky bet six months ago. With the world’s most powerful central bank now tilting hawkish, the foundation looks shakier than ever.
Markets pricing in Fed tightening by year-end has Tokyo in a whirl. A hawkish pivot in Washington will pull capital toward US Treasuries, threatening the Nikkei’s bull run — and the weak yen that juiced corporate profits now leaves Japan exposed to surging import costs and even higher inflation.
Japan is already grappling with stagflation. Growth is tracking at just 0.5%, while the BOJ’s internal inflation gauge runs at 2.8% year-on-year — 5.6 times the GDP growth rate. Given those headwinds, last week’s BOJ rate hike to 1%, a 31-year high, may be the last for a long while. A BOJ on hold while the Fed tightens is a near-perfect recipe for renewed yen freefall.
“A key factor behind the acceleration of yen weakness has been the significantly widening gap between domestic and overseas monetary policies,” says Ataru Okumura, strategist at SMBC Nikko Securities.
Jakarta is on the ropes. The rupiah is down 7% this year — not even halfway through 2026 — and sitting at an all-time low, below even the depths of the 1997-98 Asian financial crisis. President Prabowo Subianto’s government and Bank Indonesia are intervening frantically to stem capital flight from Southeast Asia’s largest economy.
The pressure “signals that the US-Iran war is now materially impacting Indonesia’s economy and external balance,” says UOB Kay Hian analyst Suryaputra Wijaksana — a problem likely to “persist throughout 2026.”
Prabowo’s twin current-account and trade deficits are colliding with a runaway dollar, while Iran war risk-off sentiment leaves little room in global portfolios for currencies like the rupiah. His insular policies since October 2024 are doing the rest, repelling investors who might otherwise step in.
The political stakes couldn’t be higher. Prabowo is a protégé of the late dictator Suharto, who was ousted by mass student protests during the Asian financial crisis.
The five presidents who followed spent the next quarter-century dismantling Suharto Inc.‘s sprawling kleptocracy. The fifth, Joko Widodo, arguably did the most — stabilizing the political system, pushing through infrastructure reforms, improving transparency, and steering Indonesia through Covid better than most peers.
Prabowo has spent less than two years unwinding much of that progress. He abruptly fired internationally respected Finance Minister Sri Mulyani Indrawati in September 2025, then unleashed a wave of fiscal overreach, state interventionism, and central bank meddling.
Global markets are now seeing through the spin — including MSCI, which has been threatening to downgrade Indonesia from developing to frontier market status, with a decision expected Wednesday.
The Fed’s hawkish pivot is compounding Indonesia’s pain. Oxford Economics economist Artie Lam flags Indonesia among the countries most certain to “face the most market pressure to rein in spending” — where currency and yield movements are already eroding fiscal space. The rupiah’s slide “weighs materially on the fiscal balance” and feeds broader doubts about both fiscal credibility and central bank independence.
India is fighting the same battle. A falling rupee is making crude oil and other critical imports — electronics, industrial inputs — significantly more expensive, stoking domestic inflation and pushing foreign investors toward the exit. Dollar-denominated debt service is getting costlier by the day.
Few countries have been knocked off balance this fast. The year began with Modi’s BJP toasting a “Goldilocks moment” for Asia’s third-largest economy — growth and inflation perfectly aligned, or so the story went. That narrative has curdled quickly. The rupee was Asia’s worst-performing currency in 2025, down 5%. It’s fallen another 5.4% since January, now trading near 95 to the dollar.
New Delhi couldn’t have predicted the US-Israel strike on Iran on February 28, or the oil shock that followed. But Modi’s BJP has had twelve years to address the twin current-account and budget deficits now putting the rupee in harm’s way. Those pre-existing conditions are what turn an external shock into a crisis.
Nobody knows where the Warsh Fed lands six months from now — or how Trump, who tried to fire Powell and have him indicted, reacts if his chosen dove fails to deliver rate cuts. But the dollar surging amid a Fed tightening cycle wasn’t on Asia’s 2026 worry list. It is now.
As HSBC economist Frederic Neumann puts it: “Monetary officials will remain on guard in Asia: a bouncy US dollar means that there is little reprieve for now.”
A surging dollar is making everything worse, threatening to suffocate Asian currencies and leaving governments across the region scrambling to sandbag their financial systems.
We’ve seen this movie before. The 1997 crisis had its roots in the Fed’s 1994-95 tightening cycle, when then-Chair Alan Greenspan — who died Monday at 100 — doubled short-term rates in just 12 months.
That cycle tipped Mexico into crisis, bankrupted Orange County, California, and shuttered bond giant Kidder, Peabody & Co. Then it came for Asia. By 1997, the resulting dollar surge made currency pegs untenable. Thailand devalued first, then Indonesia, then South Korea — all three going hat-in-hand to the IMF and others for bailouts totaling US$118 billion.
Malaysia and the Philippines were pushed to the brink without seeking rescues.
Emerging markets have been haunted by Fed tightening ever since. The 2013 “taper tantrum” — mere hints of the Fed hitting the brakes — was enough to prompt Morgan Stanley to publish its infamous “fragile five” list: Brazil, India, Indonesia, South Africa, and Turkey. No emerging economy wanted to be on it.
Now a surging dollar is complicating Asia’s development plans all over again — history’s greatest capital magnet hoarding wealth needed to finance deficits, stabilize bond yields and keep equity markets afloat. The fact that no one yet knows what to make of the Warsh era hardly helps.
Follow William Pesek on X at @WilliamPesek
