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.

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“Mitul Kotecha, head of global markets research Asia & FX strategy at Credit Agricole CIB, is more optimistic on emerging markets than before but sees risk aversion among investors in EM equities. He tells ET NOW, investors are awaiting the election outcome and says it’s essential a reform-oriented government comes to power.”

Some respite for emerging market assets

Large gains in many emerging market currencies have been registered in the wake of policy rate hikes in Turkey and to a lesser extent in India. Also some encouraging data in Asia in particular a widening in South Korea’s current account surplus helped to shore up confidence in regional currencies. Not wanting to throw cold water on the move but while everyone is lauding Turkey for its bold move the reality is that its aggressive rate hike will hit growth at a time when its economy is fragile.

The massive rate hike in Turkey (repo rate hiked from 4.5% to 10%) fuelled a bounce in risk appetite nonetheless, although most risk measures have only reversed part of the move registered over recent days. It is way too early to suggest that everything is returning back to normal and the rally in risk assets looks vulnerable to fading out over coming days.

While I am not a proponent of the nervousness in emerging markets turning into a renewed crisis, uncertainty about country specific issues such as slowing growth and deleveraging in China, fundamental and political uncertainties / elections in Thailand, India, Indonesia. Ukraine and countries in the “fragile 5” against the background of Fed tapering, suggest rocky times ahead.

Moreover, the market may have priced in another $10 billion of Fed tapering today but the reality is that the global liquidity injections provided by the Fed will be reduced over coming months. Additionally a likely renewed rise in US Treasury yields will add another layer of pressure on emerging market assets.

Although emerging market currencies have strengthened most G10 currencies remain in a tight range. G10 FX gains were led by the AUD and NZD while JPY came under renewed pressure. This pattern is likely to continue in the near term. Aside from the Fed FOMC there will be some attention on the Reserve Bank of New Zealand too. The RBNZ is expected to keep policy rates unchanged but there is a small chance of rate hike or at the least a hawkish accompanying statement which ought to keep the NZD supported.

Risk assets under growing pressure

The growing turmoil in emerging markets is inflicting damage on risk assets across the board and no let up is expected in the near term. Even the rally in US Treasuries has failed to provide any relief to risk assets given the weight of negative sentient. Whether triggered by concerns about a slowing in Chinese growth, Argentina’s letting go of its currency support, and/or political tensions elsewhere such as in Thailand and Ukraine or a combination of all of these, the picture looks increasingly volatile.

Additionally, earnings and valuation concerns are acting to restrain equity markets. Finally, lurking in the background as another weight on asset markets is Fed tapering, with a further USD 10 billion reduction in asset purchases expected to be announced by the Fed this week (Wednesday). The combination of the above spells more bad news in the days ahead, with risk assets set to remain under pressure this week.

Amid the growing gloom in global markets there are still some key data releases and events that will garner some attention this week. In the US as noted the Fed FOMC meeting is the main event, but December new home sales today, January consumer confidence tomorrow and Q4 GDP on Thursday will also be important. However, the former two releases are set to record declines implying a mixed slate of US releases this week.

In Europe, coming off the back of some encouraging flash purchasing managers’ indices the January German IFO business climate index will record its third consecutive gain, while Spanish GDP is set to record its second consecutive quarterly gain. A slight rebound in January inflation is unlikely to stand in the way of a further reinforcement of forward guidance by the European Central Bank.

In Japan Trade data reported today revealed an 18th straight month of deficit while inflation data will reveal that the Bank of Japan still has a lot of work to do to reach its 2% inflation target implying that there will be some discomfort with the recent rebound in the JPY. Finally, expect no change from the RBNZ at its policy meeting on Wednesday, which will leave the NZD under further pressure.

Emerging market currencies under pressure

One of the key factors that have provoked the current bout higher risk aversion was the sub-50 Chinese manufacturing confidence gauge (PMI) which has intensified concerns about slowing growth . Additionally reports regulators in China have issued warnings about credit to the coal industry has reinforced debt fears in the country.

Domestic fundamental and political pressures in other currencies have contributed to the malaise in emerging markets, with a major drop in the Argentine peso and pressure on many other high beta emerging market currencies (including the usual suspects Turkish lira, South African rand and Indian rupee).

A deteriorating outlook for many emerging markets currencies based on concerns about the impact of Fed tapering and slowing emerging markets growth appears to be increasingly intensifying. Competition for capital as the Fed tapers will make things worse. The pressure is unlikely to ease quickly leaving many EM currencies vulnerable to a further sell off.

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