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.

Asian currencies under pressure

The close to 1% drop in the USD index over recent days is misleading in terms of the USD’s performance against emerging market currencies where it has registered strong gains. For example the ADXY (Asian USD index) has dropped to its lowest level since early September 2013 and looks set to decline further as Asian currencies face more pressure. The best performers in this environment are traditional safe havens, especially JPY and CHF while the EUR and Scandinavian currencies have also capitalised on the weaker USD.

The drop in the USD against many major currencies reflects the fact that positioning had reached extreme levels prior to the sharp moves at the end of last week. For instance, net long USD speculative positions (according to the CFTC IMM data) had risen to the highest level since June 2013 while in contrast EUR positioning had dropped to its lowest since July 2013. The subsequent position adjustment will have proved to be a healthy correction that will set the USD up for an eventual rebound and the EUR for a sell off.

The sharp drop in US Treasury yields will undermine the USD further in the near term, however, and the mixed slate of US data releases will offer the currency little assistance. Nonetheless, the USD is expected to stay firm against Asian currencies. Notably capital flows from Asian equity markets have increased over recent weeks, with Philippines, South Korea, and Thailand on track to register outflows for the first month of the year. Against this background it is unsurprising that both the KRW and PHP are the two worst performing Asian currencies so far this year. While I expect a reversal in both, the near term outlook is for further pressure.

JPY selling momentum slows

Markets have few leads to trade off following yesterday’s President’s Day holiday in the US. Nonetheless, caution appears to be settling in ahead of this weekend’s Italian elections, especially in Europe.

European Central Bank President Draghi’s address to the EU parliament did little to stir markets as he didn’t elaborate much on his post ECB press conference in February. The most notable comment was that he urged the G20 to have very “strong verbal discipline” on talking about currency movements.

Despite the Italian election caution most risk measures appear to be well behaved. Equity volatility has continued to drop and gold prices have stabilised following the recent sharp decline. The highlight of the data calendar today is a likely gain in the February German ZEW survey.

Currency markets are rangebound but it is notable that USD/JPY has struggled to sustain gains above the 94.00 level, with upward momentum in the currency pair appearing to fade. Comments by Japan’s Finance Minister Aso that the government was not considering changing the central bank law at present or buying foreign bonds helped to dampen USD/JPY.

Although the G20 meeting effectively gave the green light for further JPY declines, a lot is in the price in terms of policy expectations and any further JPY weakness is likely to be much more gradual. USD/JPY 94.46 will offer strong resistance to further upside.

Asian currencies continue to deliver a mixed performance, with JPY sensitive currencies including SGD, KRW and TWD remaining on the back foot. The SGD is the most highly correlated Asian currency with JPY, with a high and significant correlation between the two. Any further drop in JPY will clearly bode badly for SGD but the inability of the JPY to weaken further may help to moderate pressure on the SGD in the near term.

Although the KRW has rebounded over recent days one risk to the currency is continued outflows of equity portfolio capital. South Korea is one of the only countries in Asia to have recorded outflows (around USD 1.2 billion year to date). However, this month the outflow appears to have reversed, with around USD 500 million in inflows registered month to date. In part the outflows of equity capital from South Korea in January reflected concerns about North Korea. Such concerns have receded but the risks remain of more sabre rattling and/or more nuclear tests from the North.

Sell USD / Asia FX on rallies

The biggest move this year appears to have come from the VIX ‘fear gauge’ which has dropped sharply contributing to an overall improvement in risk appetite. Although the VIX dropped further overnight equity sentiment overall continues to sour as fiscal cliff euphoria faded further and markets brace for the reality of likely protracted negotiations to raise the debt ceiling and avert huge spending cuts.

Caution over a plethora of fourth quarter earnings reports over coming weeks is also limiting upside for risk assets. Economic drivers were thin on the ground overnight but weak German exports data (which likely contributes to an overall decline in GDP in Q4) an increase in Eurozone unemployment and rumours of a French ratings downgrade did not help.

In the US the news was a little better as small business confidence reversed its sharp November drop. A limited data slate today will leave markets focussed on upcoming earnings, with consensus estimates for Q4 at a relatively low 2.9% QoQ.

Asian currencies have registered mixed performances so far this year. Resistance from some Asian central banks, notably Korea, has limited the appreciation of currencies. The incentive to prevent further strength has increased especially as a key competitor the JPY has weakened.

Maintaining its robust performance over 2012 the PHP has been the best Asian FX performer so far in 2013 followed by the THB. Similarly the IDR has maintained its negative performance registered last year. SGD is also likely to underperform further as the currency finds itself being increasingly used as a funding currency for taking long positions in other Asian FX.

We note that risk appetite has a limited correlation with Asian currencies at present but firm capital inflows will continue to provide support, with a sell USD / Asia FX on rallies environment set to persist.

SEK weaker, Asian FX still following CNY

Despite a series of better than expected data releases in the US including October durable goods orders, Case Shiller house prices and consumer confidence the lack of progress towards resolving the fiscal cliff is weighing on risk appetite. Comments by Senate Majority leader Reid of little progress in budget talks hit equity markets and will cast a shadow over risk appetite today.

News that the US did not label China a currency manipulator did little to help as such an outcome was expected in the US Treasury’s semi-annual currency report, especially given the recent appreciation of the CNY. Any positive boost from the Greek aid deal also proved short lived. The lack of major data releases or events today will likely most asset classes within recent ranges.

The EUR has failed to hold onto Greek debt deal inspired gains but looks well supported above 1.2900. The realisation that any aid to Greece will still be subject to several parliamentary approvals, ongoing reforms and a successful debt buy back may have dampened sentiment or more likely the deal was already priced in.

Looking ahead there is little on the economic front to provide any directional impetus for EUR/USD aside from M3 money supply data where a modest increase is expected in October. In contrast the run of better US economic data is set to continue, with October new home sales and the Beige Book likely to provide encouraging reading. The difficulty in reaching agreement on the fiscal cliff may perversely play negatively for the EUR as risk aversion pushes higher.

My quantitative models have continued to point to EUR/SEK upside. Economic data yesterday provided more negative news for the currency, with business and consumer confidence for November recording bigger than expected declines. Q3 GDP data tomorrow will confirm the slowing in the economy, while retail sales are set to record a decline.

However, while the SEK remains vulnerable it is already pricing in some bad news. I suspect that the 26 October high around EUR/SEK 8.7194 will be difficult to break through. I prefer to play SEK weakness versus NOK at current levels.

Asian currencies remain relatively well supported and continue to track movements in the CNY rather than the USD although slightly higher risk aversion will weigh limit the ability of Asian FX to strengthen. USD/KRW looks likely to continue to struggle to break below the 1080 level as markets remain wary of official action to weaken the currency. A likely unchanged rate decision from the Bank of Thailand ought to leave the THB to trade within its tight range.

CNY influence on Asian FX continues to grow

Asian currencies remain generally well supported both by a softer tone to the USD in general as well as a stronger Chinese currency, CNY. Since the USD/RMB high of 6.3964 on 25 July the RMB has appreciated by around 2.4% vs. USD. This equates to an annualized pace of appreciation of around 6.2%. The RMB is unlikely to continue to strengthen at such a rapid pace and could even be prone to a softer tone into year end.

Potential renewed weakness in the CNY could presage downside risks to Asian currencies. Also worth noting is the fact that equity portfolio capital inflows to Asian have slackened over recent weeks (Indonesia, Philippines and Taiwan registered outflows over October), a factor that could also pose risks to Asian currencies.

The influence of the RMB on Asian FX has continued to grow. Correlations or sensitivities between Asian currencies and the CNY remain are stronger than Asian FX sensitivities to USD movements. The implication is that USD index gyrations are having less influence on Asian currencies.

The most correlated currencies with the CNY are KRW, SGD and TWD although all Asian currencies with the exception of the INR register statistically significant correlations with the movements of USD/CNY. Notably our quantitative models show that the KRW, SGD and TWD are overbought relative to their short term fair value estimates.

While the USD is still influential in driving some Asian currencies several currencies including KRW, CNY and IDR do not possess a statistically significant sensitivity to the USD over the past 3-months. Should the CNY undergo renewed weakness it will mean that the currencies noted above namely KRW, SGD and TWD will be the most vulnerable to weakness given their high sensitivity to CNY.

Equity flows to Asia surge

Equity flows to Asia have begun the year in solid form. Although not quite as strong as in 2010 the pace of recent acceleration in flows has been more rapid, suggesting that it will soon overtake the year to date inflows seen over 2010. In total Asia has registered around $4.955 billion in foreign equity inflows. Korea has received the biggest inflows at $2.4 billion followed by India $1.04bn and Taiwan $1.03 billion.

The Indian rupee (INR) has been a clear beneficiary of such flows while the Korean won (KRW) has also strengthened. I suspect that official resistance may have limited Taiwan dollar (TWD) gains but clearly the risk on start to the year has resulted in strengthening inflows and in turn stronger Asian currencies.

Unless there is a disaster in Greece or elsewhere in Europe next week there is little to stop the short term trend but I remain wary over coming weeks and am cautious about extrapolating this trend forward. Like in 2010 and 2011 equity flows began the year strongly only to drop over following weeks and currencies were not slow to follow.

Follow

Get every new post delivered to your Inbox.

Join 577 other followers

%d bloggers like this: