Asian currencies weaken

Asian currencies are facing pressure today in the wake of a generally firmer USD tone although the fact that US Treasury yields continue to edge lower will provide some relief. There has been some good news on the flow front, with the region registering a return of equity portfolio flows so far this month to the tune of USD 1.56 bn, with all countries except Vietnam registering equity inflows. Notably however, India has registered strong outflows of equity capital this week, which could cap gains in the INR.

Weakness in the CNY and CNH has been sustained with the USD grinding higher against both. Recently weaker economic news and expectations of some form of policy measures on the FX front (perhaps band widening) soon after the end of the National People’s Congress will keep the CNY and CNH under pressure.

March’s biggest outperformer the IDR has been an underperformer overnight although its drop has been small compared to the magnitude of recent gains. Nonetheless, USD/IDR may have found a tough level to crack around 11400.

The INR is set to trade with a marginally weaker tone but further direction will come from today’s releases of January industrial production and February CPI inflation data. A move back to 61.50 for USD/INR is likely unless the data comes in strong.

Chinese yuan drops further

China lowered the CNY’s fixing by 0.18% to 6.1312 per USD today, the biggest cut in the fixing since July 2012 to the weakest level since December 3. The move comes quickly in the wake of the poor trade data over the weekend and in particular the sharp 18.1% drop in exports compared to a year earlier.

Although lunar new year timing may have impacted the data, the drop in exports is still significant and may explain why China has been forcing a weaker currency over recent weeks.

Additionally February inflation data in China was soft, with price pressures recording a broad based decline, with CPI inflation falling to a 13 month low of 2% YoY. The soft inflation data adds further reason for the authorities in China to push for a weaker currency.

USD/CNY and USD/CNH both moving higher in reaction to the data and weaker fixing, with the Chinese currency likely to remain under pressure in the short term both onshore and offshore.

JPY and Asian FX outlook

JPY is facing a double whammy of upward pressure related to both rising risk aversion and a narrowing US yield advantage over Japan. The latter influence has been significant, with 10 year US Treasury yields dropping by around 70bps since the end of last year, versus 10 year Japanese JGB yields. The net result is that the currency pair has fallen sharply over recent weeks and will remain constrained until US yields resume their ascent.

In the near term the escalation of tensions in the Ukraine will fuel increased safe haven demand for JPY potentially leading to a test of a test of technical support around USD/JPY 100.62 (11 September 13 high). However, strong demand around the 101.20-30 level suggests that it may require another leg lower for US yields to fuel a further sharp drop in USD/JPY.

Asian currencies are set to continue to show some relative resilience to events in Ukraine although a weaker bias is expected. Most currencies remain relatively insensitive to gyrations in risk appetite except KRW which registers the biggest correlation with our risk barometer.

Overall, lower US yields will help provide some support to Asian currencies and investors will continue to differentiate based on domestic factors rather than shifts in risk appetite. Additionally some relative stability in the CNY / CNH may also help to limit pressure on Asian currencies.

CNY / CNH pressure continues

CNY/CNH the downward pressure is unlikely to abate in the near term. The desire to 1) implement two way risk, 2) higher volatility and 3) curb strong capital inflows 4) prepare for band widening, will not end quickly. A resumption of a strengthening trend in CNY / CNH will undo these aims quickly as inflows resume. Hence, if China really wants to instigate significant volatility in the currency the weakening trend is set to continue for a while to come.

At what level does the weakness in the CNY stop? Well my quantitative model already suggests that USD/CNY has already overshot its short term fair value (6.0904) but the bottom line is that this overshoot may persist for several weeks. Nonetheless, CNY has reversed all of its strength versus USD from early October and further weakness may be less rapid.

Further out, the CNY is likely to resume a stronger tone but this may be some weeks away. China continues to benefit from large foreign exchange reserves and a healthy external balance and this will eventually result in upward pressure on the currency. A move back to around 6.00 versus USD by year end remains likely but China’s authorities will want to ensure that the market does not believe that the path there will be a one way street.

Australian dollar rallies, Korean won bounces back

On the currency front, the best performers so far this year have been an odd combination of JPY, NZD and AUD versus USD. JPY has benefitted from both compressed yield differentials with the US and risk aversion but its gains are likely to reverse over the coming weeks as these factors reverse.

I have been generally more constructive on AUD and NZD than the consensus and remain so. Both AUD and NZD look oversold and will gradually appreciate further, especially as both the RBA and RBNZ have now likely ended their easing cycles, with the latter set to raise policy rates by the end of this quarter. AUD/USD breached 0.90 this morning helped by a strong business confidence reading for January.

Most Asian currencies have rebounded so far this month, with some of the biggest losers over January recording gains. The KRW has been the best performer in February recording gains despite continued outflows of equity capital. Korea has recorded $1.26 billion in equity outflows so far this month, the highest among Asian countries.

In contrast bond inflows into Korea have been relatively solid over January and this continued into February, helping to provide some support to KRW despite equity outflows. Helping the KRW is the fact that is much less sensitive to US bond yields than many other Asian currencies helping it to avoid any fallout from higher US yields in February. USD/KRW is on path for a break below support around 1070.

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