CNY / CNH pressure continues

February 26, 2014 — Mitul Kotecha

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.

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Australian dollar rallies, Korean won bounces back

February 11, 2014 — Mitul Kotecha

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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Some respite for emerging market assets

January 29, 2014 — Mitul Kotecha

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.

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Asian currencies under pressure

January 27, 2014 — Mitul Kotecha

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.

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Emerging market currencies under pressure

January 24, 2014 — Mitul Kotecha

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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