Asian currencies – What’s correlated with what?

May 17, 2011 — Mitul Kotecha

Asian currencies as reflected in the performance of the ADXY index have been on bit of a rollercoaster ride over recent weeks, dropping sharply in the face of a resurgent USD (note most Asian currencies have had a high correlation with the movements in the USD index over the past three-months) only to strengthen briefly before resuming weakness. Since the end of last month almost all Asian currencies are weaker, with the biggest falls led by MYR, KRW, SGD and INR.

Correlation analysis shows that Asian currencies are not particularly being influenced by yield differentials at present, with only USD/IDR and USD/PHP possessing a significant correlation with 2-year bond differentials. In the case of the IDR there has been a narrowing in the yield differential with the US over recent weeks as Indonesian yields have dropped, a factor that could be undermining the IDR at present.

Similarly risk aversion does not appear to be playing a major role in influencing Asian currencies, with a low correlation registered between my Risk Aversion Barometer and all Asian currencies over the past three-months. However, equity performance is more important for some currencies, with the SGD, THB, PHP, IDR and TWD all having a high sensitivity to the performance of their local equity market. Interestingly the INR is less sensitive to equity performance even though India has recorded heavy outflows of equity capital over recent weeks.

Asian currencies are likely to continue to track the gyrations of the USD in general over the short-term as has been the case over recent weeks but it will not be a one way bet for the USD. Whilst I remain bullish on the USD’s prospects over the medium term I am cautious about the ability of the USD to sustain its currency bounce given that there has not been any back up in US bond yields or any clarification on what the Fed will do after QE2 has been completed.

Against this background I do not expect Asian currency weakness to extend much further. Top picks for the year are KRW and PHP as well as the CNY. In any case given the strong influence of general USD direction on Asian currencies, I suggest playing long Asian FX positions versus EUR over coming months, especially given that the EUR is likely to slide much further against the USD by year end, with 1.30 remaining my target.

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RBA on hold, RBI hikes rates

May 3, 2011 — Mitul Kotecha

News of the death of Osama Bin Laden gave the USD a lift and its gains have extended for a second day. Extreme short market positioning as well as increasing risk aversion (perhaps due to worries about retaliation following Bin Laden’s death) have helped the USD.

However, the boost to the USD could be short-lived in the current environment in which it remains the preferred global funding currency. Indeed, the fact that US bond yields have dropped sharply over recent weeks continues to undermine the USD against various currencies.

The USD firmed despite the US ISM manufacturing index dropping slightly, albeit from a high level. The survey provided some useful clues to Friday’s US jobs report, with the slight decline in the employment component of the ISM survey to 62.7 consistent with a 200k forecast for April payrolls.

Ahead of the European Central Bank (ECB) meeting on Thursday hawkish rhetoric from new Council member and Bundesbank chief Weidmann (replacing Weber) and more reassurances from Greek and EU officials that there will be no debt restructuring or haircut on the country’s debt has helped the EUR although it is notable that it could not sustain a foot hold above 1.49. Eurozone bond yields have risen by around 20bps compared to US yields over the past month, a fact that suggests that the EUR may not fall far in the short-term.

USD/JPY is trading dangerously close to levels that may provoke FX intervention by the Japanese authorities. General USD weakness fuelled a drop in USD/JPY which has been exacerbated by a rise in risk aversion over recent days (higher risk aversion usually plays in favour of a stronger JPY). The biggest determinant of the drop in USD/JPY appears to a narrowing in bond yields (2-year bond yields have narrowed by around 20bps over the past month) largely due to a rally in US bonds.

Unsurprisingly the Reserve Bank of Australia (RBA) left its cash rate on hold at 4.75%. The accompanying statement showed little inclination to hike rates anytime soon, with credit growth noted as modest, pressure from a stronger exchange rate on the traded sector and temporary prices shocks which are expected to dissipate. The only indication that rates will eventually increase is the view that longer term inflation is expected to move higher.

I look for further rate hikes over coming months even with the AUD at such a high level. AUD has lost a bit of ground after hitting a high just above 1.10 against the USD and on the margin the statement is slightly negative for AUD. A slightly firmer USD overall and stretched speculative positioning, with IMM AUD positions close to their all time high, points to some downside risks in the short-term.

In contrast India’s central bank the RBI hiked interest rates by more than many expected. Both the repo and reverse repo rates were raised by 50bps, with the central bank governor highlighting renewed inflation risks in his statement. The decision reveals a shift in RBI rhetoric to an even more hawkish bias in the wake of rising inflation pressures, which should be beneficial to the rupee.

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Financial Times Guest post: Rupee can serve as a reserve currency too

April 14, 2011 — Mitul Kotecha

Please see below an excerpt from the Financial Times beyondbrics section in which I wrote a guest post about the Indian rupee.

Amidst the euphoria surrounding the internationalisation of China’s currency, the renminbi, attention on the Indian rupee appears to have fallen into the shadows. Admittedly China has been announcing new measures on the path to internationalisation almost on a weekly basis whilst India appears to have taken a more gradual approach, but it’s not too late for India to regain some of the limelight.

Perhaps it is surprising that the rupee is hardly talked about when discussing reserve currencies. The last BIS Triennial Survey of FX market activity revealed that the rupee accounted for 0.9 per cent (the same as the Russian rouble) of daily foreign exchange market turnover, which may seem small compared to the 84.9 per cent of turnover accounted for by the USD or 39.1 per cent by the EUR but is still ahead of many other developing currencies including China, which accounts for only 0.3 per cent of turnover. Moreover, India’s share of turnover has risen steadily from 0.1 per cent in 1998.

Read the rest at http://blogs.ft.com/beyond-brics/2011/04/14/guest-post-rupee-can-serve-as-a-reserve-currency-too/

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Markets in limbo ahead of policy rate decisions

April 6, 2011 — Mitul Kotecha

Markets are generally range-bound ahead of tomorrow’s Japan, Eurozone and UK interest rate decisions, as reflected in the flat performance of equity markets overnight. Risk appetite remains positive though still lower than the high levels seen during most of March. China’s interest rate hike did not change the market’s perspective, with markets reacting well.

Overnight the Fed FOMC minutes reflected a range of opinions on the timing of the end of QE2 and the Fed’s exit strategy but the majority view was to end QE2 as planned at the end of June leaving markets, with little new to digest. The USD was a little undermined by a weaker than expected US March ISM non-manufacturing survey but losses are likely to be limited.

Meanwhile there was more negative peripheral news in Europe, with Moody’s cutting Portugal’s sovereign credit ratings by one notch, with Moody’s highlighting the urgent need for financial support from the EU. Portuguese debt took a hit but eurozone markets in general including the EUR continue to take such news in their stride, with EUR/USD holding above 1.4200. Firm readings for the eurozone final services purchasing managers index (PMI) in March helped to support sentiment, outweighing the negative impact of a drop in eurozone retail sales.

GBP was a key outperformer, helped by a much stronger than expected services PMI, which helped GBP/USD breach 1.63 overnight. Today’s industrial and manufacturing production data will likely reveal firm readings too, helping GBP to consolidate its gains but the currency looks rather rich around current levels, with risks skewed to the downside.

JPY was another mover, having breached 85.00 versus the USD, with USD/JPY now some 6 big figures higher from its post earthquake lows. Japanese authorities will undoubtedly see a measure of success from their joint intervention but the reality is that the shift in bond yields (2-year US / Japan yield differentials have widened by close to 30 basis points since mid March, are finally having some impact on USD/JPY as reflected in the strengthening in short-term correlations.

EUR/USD remains resilient to negative peripheral news such as the Portugal credit ratings downgrade, with further direction from tomorrow’s European Central Bank (ECB) meeting and accompanying statement. The risk that the ECB is not as hawkish as the market has priced in holds some downside risks to EUR.

Asian currencies are holding up well though it looks as though the ADXY (Bloomberg-JP Morgan Asian currency index) may have hit a short term barrier. Range trading for EUR/USD suggests little directional influence for Asian currencies in the short-term. Nonetheless, portfolio capital inflows continue to support Asian FX with all Asian equity markets recording foreign inflows so far this month. In particular, KRW continues to outperform. Note that Korea has recorded a whopping inflow of $1.1bn in equity inflows month-to-date.

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Equity Flow Reversal Supports Asian FX

March 30, 2011 — Mitul Kotecha

Asian currencies have rebounded smartly from their post Japan earthquake lows on March 16. The ADXY (Bloomberg-JP Morgan Asia Currency index) is now at its highest level since September 1997 reflecting a sharp rebound in capital inflows to the region. The performance of Asian currencies continues to correspond closely with the movement in capital flows.

Although almost all Asian equity markets have registered outflows so far this year (total equity outflows -$6.2bn), the trend is reversing. Over the past month there has been a major slowing in capital outflows for most countries in Asia whilst India, Thailand and the Philippines have actually registered sizeable inflows. South Korea is notable in that there has been a sharp increase in equity capital inflows over the past week.

Although there has been much focus on a rotation of capital flows out of Asia and into developed economies this year, it is worth noting that the pattern of equity flows in Q1 2011 has not been too different from that witnessed in the past couple of years. In both 2009 and 2010 equity outflows were recorded over the two (2010) or three (2009) months of the year before a reversal took place. This pattern looks like it is repeating itself.

Clearly the environment for Asian equity markets is not as supportive as it was last year given the belated tightening in monetary policies being undertaken by many central banks and prospects of an end to QE2 in the US. Whilst this will result in some reduction in capital flows to the region compared to last year, the overall outlook is positive. Easing risk aversion (our risk aversion barometer has already reversed all of its post Japan earthquake spike and is trending lower), positive growth outlook and maintenance of low US rates point to more inflows.

One currency in particular that will benefit is KRW, with a further drop in USD/KRW likely over coming weeks. KRW has already strengthened by around by around 2.7% since its post Japan earthquake low making it the best performing currency since then. Further gains are likely; a test of USD/KRW 1100 is on the cards in the short-term, with the year end target standing at 1050.

Why buy KRW? 1) Korea has registered the biggest improvement in equity capital flows recently, 2) KRW has been the most sensitive Asian currency to risk over the past month and therefore benefits the most as risk appetite improves, 3) Estimated Price/Earnings ratio for Korean equities looks cheap compared to its historical z-score according to our estimates. As a result our quantitative model on USD/KRW based on commodity prices, risk aversion and equity performance highlights the potential for significantly more KRW strength.

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