Asian currencies vulnerable to equity outflows

Asian currencies are set to continue to trade cautiously. One big headwind to further appreciation is the fact that there has been a substantial outlook of equity capital over recent weeks. Over the last month to date Asian equity markets have registered an outflow of $3.3 billion in outflows. However, whilst Taiwan, South Korea, Thailand and India have seen outflows Indonesia, Philippines, and Vietnam have registered inflows.

The net result is that equity capital inflows to Asia so far this year are almost flat, a stark contrast from 2009 and 2010 when inflows were much higher at the same point in the year. The odds for further strong inflows do not look good, especially as the Fed ends QE2 by the end of June. While a sharp reversal in capital flows is unlikely, it also seems unlikely that Asia will register anywhere near as strong inflows as the last couple of years.

This will have a significant impact on Asian currencies, whose performance mirrors capital flows into the region. Almost all Asian currencies have dropped against the USD so far this month and could remain vulnerable if outflows continue. Given the relative stability of the USD over recent weeks and imminent end to QE2, the better way to play long Asia FX is very much against the increasingly vulnerable EUR.

The THB has been the worst performing currency this month but its weakness has been attributable to upcoming elections on July 3, which has kept foreign investor sentiment cautious. Thailand has seen an outflow of $812mn from its equity market this month. Polls show the PM Abhisit’s party trailing the opposition and nervousness is likely to persist up to the elections at least. THB weakness is not likely to persist over coming months, with USD/THB forecast at 29.2 by year end.

USD/KRW has been whipsawed over the past week but made up ground despite a continued outflow of equity capital over recent days. KRW has been particularly resilient despite a firmer USD environment and a drop in consumer sentiment in June. Next week the KRW will likely continue to trade positively, helped by a likely firm reading for May industrial production on Thursday. USD/KRW is set to trade in a 1070-1090 range, with direction likely to come from Greece’s parliament vote on its austerity measures.

TWD has traded weaker in June, having been one of the worst performing currencies over the month. USD/TWD does not have a particularly strongly correlation with movements in the USD or risk aversion at present but the currency has suffered from a very sharp outflow of equity capital over recent weeks (biggest outflow out of all Asian countries so far this month). Next week’s interest rate decision on Thursday by the central bank (CBC) will give some direction to the TWD but a 12.5bps increase in policy rates should not come as a big surprise. TWD is likely to trade with a weaker bias but its losses are likely to be capped around the 29.00 level versus USD.

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