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.

The week ahead

There are plenty of events to chew on over coming days including central bank decisions in Japan tomorrow and New Zealand on Wednesday. The Bank of Japan is unlikely to ease policy further so soon after its actions to boost loan growth while in contrast the RBNZ is set to begin its hiking cycle. On the data front US releases will still be weather impacted to some extent although February retail sales is likely to post a small gain. Moreover, Michigan confidence is set to rise, boosted by higher equity prices.

In Europe, attention will focus on industrial production releases in January, with French and Spanish IP data due to be released today. Overall production is likely to have expanded at a healthy clip of 0.4% MoM in the Eurozone as indicated by survey data. Finally, Australian jobs data is set to show some improvement on Thursday as the pace of deterioration in job market conditions slows.

In Asia the reverberations from the weaker Chinese data will likely impact sentiment across the region. Exports dropped by whopping 18.1% in February while imports rose more strongly than expected at 10.1% yielding a trade deficit of USD 22.99 billion. Central bank decisions in Korea and Thailand are on tap this week. Thailand is a close call, with risks of another policy rate cut but we expect the BoT to stay on hold. Currencies in Asia strengthened last week led by the IDR and INR. Gains this week will be morel limited, especially against the background of higher US yields.

My Interview on Reuters / ET Now

Watch my interview on Reuters / ETNOW. Click on the link below

videoId=276730253&videoChannel=104″>http://in.reuters.com/video/2014/02/06/need-reform-oriented-government-in-india?videoId=276730253&videoChannel=104

“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.”

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.

Fed pulls the trigger

The guessing game is finally over as the US Federal Reserve took a major step away from the extremely easy policy conditions implemented since the financial crisis by tapering its asset purchases by USD 10 billion, split equally by reduced Treasury and mortgage backed securities purchases. Indeed the Fed finally put markets out of their misery but successfully massaged the market reaction.

The Fed is set to gradually reduce asset purchases over coming months, likely ending its QE program by late 2014. The decision was supported by most Fed officials but to soften the blow the Fed strengthened its forward guidance, helping equity markets to rally while encouraging the short end of the curve.

Conversely Treasuries came under pressure and yields rose, giving a boost to the USD. Markets are likely to digest the news well in the Asian session following the lead from US markets. Nonetheless, while the Fed decision was predicated on stronger growth, the decision will presage a competition for capital especially among emerging markets.

The biggest FX reaction unsurprisingly (given its greater sensitivity to US yields) came from USD/JPY, with the currency breezing past the 104 level. However, given that US yields have not pushed significantly higher in the wake of the Fed tapering decision the boost to the USD will be limited in the short term. Indeed, FX markets will likely digest the Fed news will little reaction both in major and emerging market currencies in the short term.

Further out, the prospects for contrasting policy stances between the Fed, ECB and BoJ imply that the USD will forge higher against the EUR and JPY as well as other major currencies. Meanwhile, highly correlated currencies with US Treasury yields, in particular in the emerging markets spectrum, including INR, TRY, and BRL, will be the most sensitive to an expected rise in US yields over the coming months.

Running into resistance

Currency markets will remain range bound today although many currencies appear to be running into resistance in the wake of recent sharp moves. For instance, GBP/USD has run into a wall and lost momentum following the release of softer than forecast UK November CPI data yesterday. Unless the UK jobs report and MPC minutes today are particularly strong, GBP/USD will remain capped around 1.6300.

Similarly EUR/USD will find it difficult to make much further headway although a gain in the German IFO survey will keep the currency pair supported around 1.3730. USD/JPY’s upside is being undermined by lower US yields but firmer Japanese equities are helping to keep the currency pair supported.

AUD faced yet more jawboning by RBA Governor Stevens attempting to talk the currency lower. Given that such comments are nothing new markets are beginning to discount them, with AUD/USD likely to consolidate above 0.8900.

Asian currency direction will be limited ahead of the Fed outcome too although lower US yields will give some relief. Overall, it remains a case of South East Asian FX underperformance versus North East Asia outperformance.

The exception is the INR which has outperformed so far this month but will face an obstacle in terms of today’s RBI policy decision. 25 bps hikes in the repo and reverse repo rates are widely expected in the wake of higher inflation readings but the INR will also have one eye on the Fed FOMC given that it is the most sensitive Asian currency to US yield movements as outflows from India’s bonds continue. INR will continue to remain capped against this background.

Beware of yield sensitive currencies

Markets are becoming increasingly accustomed to the idea of an imminent Fed tapering as reflected in ongoing gains in risk assets. Indeed, these gains have taken place even in the face of comments by Fed officials overnight including Bullard and Fisher which on balance supported the view of beginning tapering sooner rather than later.

The fact that US bond yields continue to decline despite the release of a slate of firmer US and global data also suggests that a lot in terms of tapering expectations are priced in. Nonetheless, year end position adjustment may also account for some of the moves, particularly with the USD coming under near term pressure against most currencies except JPY as US yields slip.

I remain constructive on the USD given that US growth will outperform, with an attendant rise in US yields. Not only am I constructive on the USD against many major currencies, I expect the USD to strengthen versus many emerging market currencies too.

Those currencies most sensitive to US yields (10 year US Treasuries) will be among the biggest underperformers in 2014. This list includes the INR, TRY, MYR, and BRL. The rationale for weakness in these currencies is that Fed tapering and higher US yields will further increase capital outflows or at least reduce inflows to many countries.

Conversely some of the currencies least effected by tapering / higher US yields are in the top half of the likely outperformers next year including KRW and TWD.

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