Why Buy Asian FX (Part 2)

April 2, 2010 — Mitul Kotecha

The strength of portfolio capital inflows into Asia reflects the outperformance of Asian economies relative to Western economies. Whilst the US, Europe, Japan and UK have struggled to recover from recession and are likely to register only sub-par recovery over the coming months, Asian economies led by China are recovering quickly and strongly. This pattern is set to continue, leading to a widening divergence between Asian and G7 economic growth.

As growth strengthens inflationary pressures are set to build up and Asian central banks will likely raise interest rates more quickly than their G7 counterparts. Already some central banks have moved in this direction, with India, Malaysia, Philippines and Vietnam, having tightened policy. This will be followed by many other central banks in Asia over Q2 2010 including China. Even countries with close trade links to Asia, in particular Australia will rate hikes further over coming months, with Australian interest rates likely to rise to a peak of 5% by year-end.

Given that the US is unlikely to raise interest rates in 2010 higher interest rates across Asia will result in a widening in the interest rate differential with the US leading to more upside potential for Asian currencies as their ‘carry’ attraction increases relative to the USD. The most sensitive Asian currencies to interest rate differentials at present are the Malaysian ringgit (MYR), Thai baht (THB) and Philippines peso (PHP) but I believe that as rates rise in Asia, the sensitivity will increase further for many more Asian currencies.

Most Asian currencies have registered positive performances versus the USD in 2010 led by the MYR and Indonesian rupiah (IDR) and closely followed by the Indian rupee (INR), THB and South Korean won (KRW). The notable exception is China which has been unyielding to pressure to allow the CNY to strengthen. Even China is set to allow some FX appreciation although if the US labels China as a “currency manipulator” it could prove counterproductive and even result in a delay in CNY appreciation.

Looking ahead, the trend of strengthening Asian FX will continue likely led by the likes of the KRW and INR but with the MYR, TWD and IDR not far behind. Stronger growth, higher interest rates, strengthening capital inflows and higher equity markets will contribute to appreciation in Asian currencies over the remainder of the year.

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Why Buy Asian FX (Part 1)

March 31, 2010 — Mitul Kotecha

Given all the attention on Greece and European fiscal/debt woes over recent weeks it’s been easy to forget about the success story of Asian economies. Of course, there has been a lot of attention on China and the international pressure to revalue its currency. However, the stability and resilience of Asian economies has been impressive throughout the financial crisis and recent Greek saga, helping to boost the attraction of Asian currencies.

Asia has managed to avoid the fiscal/debt problems associated with many developed economies, due to much better fiscal management over recent years. There are a couple of exceptions however, including the Philippines and India, but the fiscal positions in these countries have seen an improvement and are unlikely to lead to anywhere near the same sort of problems associated with Greece and other European countries.

So far this year capital inflows into Asian equity markets have much been stronger than 2009, albeit after a rocky start to the year when flows dried up due to rising risk aversion. Since then inflows have resumed strongly. The comparison to 2008 is even more dramatic as much of Asia registered significant capital outflows that year. South Korea, India and Taiwan, respectively, have led the way in term of inflows into equity markets in 2010, with inflows of $4.3 billion, $3.7 billion and $3.3 billion, respectively.

It is no coincidence that Asian currencies are most sensitive to the performance of Asian equity markets, with strong capital inflows and rising equities leading to stronger currency performance. Asia is set to continue to be a strong destination for equity flows over coming months, which given the high Asian equity correlation with local currencies, will lead to further appreciation in most Asian FX. A likely CNY revaluation in China will also help to fuel further Asian FX upside.

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Greek Confusion, India Tightening

March 22, 2010 — Mitul Kotecha

It is highly interesting that markets could take fright from a rate hike in India but this appears to be what has happened. India’s surprise 25bps rate hike has provoked another bout of risk aversion whilst the lack of any concrete agreement on a framework for a Greek bail out dealt a further blow to confidence. FX tensions between the US and China have not helped, with China threatening retaliation to any US move to name the country as a currency manipulator in the mid April US Treasury report.

Should we really be worried by a rate hike in India or China? Whilst the India rate move reflects the fact that emerging market central banks are moving far more aggressively to raise rates than their G7 counterparts, global fears that India’s move will dampen recovery prospects are unfounded. Monetary tightening in India and China and other economies is taking place against the backdrop of economic strength not weakness.

As such the global impact on growth should be limited. Rising inflation pressure in Asia is reflection of the much quicker economic recovery, relatively low rates and undervalued currencies in the region. Not only will central banks in Asia have to raise interest rates but will also have to allow further currency appreciation.

There is still plenty of confusion about a bail out for Greece ahead of the 25-26th March EU summit. German Chancellor Merkel dampened expectations of a bailout by stating that it was not even on the agenda for the summit. In contrast, EU President Barroso has pushed EU members to agree on an explicit stand-by aid agreement for Greece as soon as possible.

There is also disagreement about whether there should be any IMF involvement, with Germany favouring some help from the Fund whilst France opposes it. Meanwhile, the Greek Prime Minister has reportedly given an ultimatum that should no aid plan be forthcoming at the EU summit, Greece will turn to the IMF for assistance.

All of this suggests more downside for EUR/USD, with a test of support around 1.3422 looming. In the event that the EU summit offers good news for Greece, EUR/USD sentiment could turn quickly so a degree of caution is warranted. Speculative sentiment for the EUR has improved according to the latest CFTC Commitment of Traders (IMM) data for the week to 16th March, with net short EUR positions at their lowest since the beginning of February. Nonetheless, the short covering seen over the past week could come to an abrupt end should there be no aid package for Greece.

The most volatile currency over the past week was GBP/USD and after hitting a high of around 1.5382 it has slid all the way back to around the 1.5000 level. Much of this was related to the gyrations in EUR/USD but GBP took on a life of its own towards the end of the week and has not been helped by comments by BoE MPC member Sentence who highlighted the risk of a “double-dip” recession in the UK.

GBP is highly undervalued and market positioning is close to a record low but a sustainable recovery looks unachievable at present. Attention this week will centre on the 2010 UK Budget announcement and markets will scrutinise the details of how the government plans to cut the burgeoning budget deficit. Failure to restore some credibility to the government’s plans will dent GBP sentiment further and lead to a sharper decline against both the EUR and USD.

Posted in Asia, central banks, China, Currencies, Economics, Economy, emerging markets, Europe, Financial crisis, Fiscal/Budget, FX, Germany, Greece, India, Interest rates, Monetary Policy, UK. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

US/China Tensions Ratchet Higher

March 17, 2010 — Mitul Kotecha

FX policy tension is a theme that looks to be making a come back. The potential for CNY revaluation continues to be hotly debated, with international pressure on China intensifying. For its part China continues to resist such calls, but growing speculation that the US will label China a “currency manipulator” in the semi-annual US Treasury report on 15 April suggests that the issue will remain very much on the radar screen.

Tensions have ratcheted higher in the wake of a proposed bill by US senators targeting countries with “fundamentally misaligned currencies” and those needing “priority action”. Any country that is targeted would then have a year to correct its currency or face a case at the World Trade Organisation. If China is labelled as a currency manipulator it could also result in anti dumping regulations.

Much of the increase in tension may be attributable to politicking ahead of the November mid-term Congressional elections but it is clear that the issue is not going away quickly. Chinese Premier Wen’s strong comments over the past weekend denying any need for revaluation of the CNY suggests that the stakes will get even higher over coming months.

It is looking increasingly difficult for the US administration to ignore Congress’ calls for stronger action on FX. Moreover, US President Obama’s pledge to double US exports within 5-years will require some USD weakness, but the USD will need to weaken against Asian currencies led by China and not just against the usual culprits such as the EUR.

There is little sign of this happening anytime soon as Asian central banks continue to intervene to prevent their currencies from strengthening. Nonetheless despite China’s insistence that it does not believe the CNY is undervalued China is likely to be edging closer to an eventual revaluation in the CNY sometime in Q2 2010 as it combined a stronger currency with higher interest rates and tighter lending to curb inflation. A stronger CNY will also spur other Asian central banks to allow stronger currencies.

A deterioration in the China/US relationship could have potentially significant FX implications. The latest US Treasury TIC report this week showed that China reduced its holdings of US Treasuries for the third straight month in January. Should China feel that it needs to retaliate against a more aggressive US trade or FX stance it could reduce its holdings of US Treasuries further.

Posted in Asia, Bond markets, central banks, China, Currencies, Economics, Economy, emerging markets, FX, Interest rates, Monetary Policy, Politics, US, US administration. Tags: , , , , , , , , , , , , , . 3 Comments »

Better Levels To Sell

March 1, 2010 — Mitul Kotecha

It is questionable how long the slight improvement in risk appetite at the beginning of this week lasts given the fickle nature of market sentiment at present and propensity for more disappointment. More than likely any relief will be short-lived given 1) there are still major concerns about fiscal/debt problems in Greece, Spain, Portugal, etc 2) the sharp decline in economic activity that various austerity plans will lead to and 3) rising social/labour unrest due to cuts in spending and hikes in taxes that need to be implemented.

Attention remains firmly fixed on Greece’s woes whilst global growth concerns have reappeared following some disappointing data releases in the US last week as well the decline in China’s manufacturing purchasing managers’ index (PMI) in February, released overnight, which although obscured by the timing of Chinese Lunar New Year holidays, suggests that China’s economy is losing some of its recent strong momentum.

Speculation of a rescue plan for Greece will likely give some support to the beleaguered EUR though it may only end up providing better levels to sell the currency. EU Monetary Affairs Commissioner Rehn is scheduled to meet with Greek Prime Minister Papandreou today against the background of talks about the possibility of EUR 25 billion in aid to Greece using state owned lenders to buy Greek debt. Any aid will likely come with demands for more action to reduce Greece’s yawning budget deficit which will fuel further weakness in economic activity.

A key test of sentiment towards Greece’s austerity plans will be the market reception to an upcoming sale of as much as EUR 5 billion in 10-year Greek bonds. Given the reassurances given by the EU the sale of bonds will likely not be too problematic. As an indication, Greek 10-year bond yields dropped sharply on Friday as sentiment improved.

The bounce in Greek debt was accompanied by a firmer EUR/USD which rebounded to a high of around 1.3667 as markets covered short positions. It’s probably way too early to suggest that the EUR has began a sustainable rally however, and more likely it has settled into a new range, with support around the 2010 low of 1.3444. The latest CFTC Commitment of Traders’ (IMM) data revealed a further increase in net short EUR positioning to a new record low in the week to 23rd February. This highlights both the weight of pessimism on the currency as well as significant potential to rebound.

Conversely, the IMM data reveals that net USD positions are at their highest in almost a year and well above their three-month average, suggesting that USD positioning is looking a bit stretched though its worth noting that positioning is still well off its record high. Nonetheless, with a bailout for Greece in the offing, risk appetite could gain a stronger foothold this week, in turn keeping the USD capped.

As for the EUR, although a lot of bad news is in the price, for the currency to rebound on a sustainable basis it will require fiscal/growth worries to recede. Despite talk of Greek aid, there is a long way to go before Europe’s fiscal/debt problems are resolved.

Posted in China, Currencies, Economics, Economy, Europe, Financial crisis, Fiscal/Budget, FX, Germany, Greece, Interest rates. Tags: , , , , , , , , , , , , , , , . Leave a Comment »
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