Resisting Asian FX Appreciation

September 7, 2010 — Mitul Kotecha

The upward momentum in Asian currencies has continued unabated over recent weeks the gyrations in risk appetite. Most Asian currencies have registered gains against the USD over 2010 with the notable exception of one of last year’s star performers, KRW which after gaining by close to 9% last year has weakened slightly this year. Last year’s best performer the IDR which raked in close to 20% gains over 2009 versus USD has continued to strengthen this year, albeit to a smaller degree. Another currency that has extended gains this year has been the THB, which is on track to beat last year’s 4% appreciation against the USD.

The strength in Asian currencies has in part reflected robust inflows into Asian equity markets. For example Indonesia has been the recipient of around $1.7 billion in equity inflows so far this year. However, India and Korea have registered even larger inflows into their respective equity markets, at around $13 billion and $7.7, respectively, yet both the INR and KRW have underperformed other Asian currencies. The explanation for this is largely due to deteriorating current account positions in both countries. Further deterioration is likely.

The fact that equity flows have had only a small impact on the INR and KRW is reflected in their low correlations with their respective equity market performance. For most other Asian currencies the correlation with equity performance has been quite high, with the THB and MYR having the strongest correlations with their respective equity market indices over the past 3-months although the SGD, PHP and IDR have also maintained statistically significant correlations.

Clearly, for many but not all Asian currencies equity market gyrations are important drivers but at a time when growth is slowing more than many had expected in the US and governments in the eurozone are implementing austerity measures which will likely result in slowing growth and a worsening trade picture in the region, central banks in Asia will become increasingly wary of allowing their currencies from strengthening too quickly.

Increasingly Asian currency strength is being met with intervention by central banks in the region buying USDs against a host of Asian currencies. Over recent weeks this intervention appears to have become more aggressive. Nonetheless, any FX intervention led weakness in Asian FX is likely to prove short lived, with renewed appreciation likely over the coming months unless risk aversion increases dramatically. In other words a drop in Asian currencies will provide better opportunities to go long.

The CNY will play an important role on the pace and pattern of Asian currency movements. Investors in the region will also have one eye on developments on the visit of US National Economic Council director Larry Summers to Beijing. The CNY has firmed over recent days but this appears to be the usual pattern when a senior US official is in town and ahead of a G20 meeting. The fact is however, that the lack of CNY appreciation since the June CNY de-pegging remains a highly sensitive issue.

China is unlikely to yield to US pressure and is set to continue to act at its own pace and comments from officials in China over the past couple of days suggest no shift in FX stance. Although the CNY has not appreciated by as much as many had hoped for or expected since the June de-pegging the path is likely to be upwards, albeit at a gradual pace. For Asian currencies a slow pace of CNY appreciation implies further reluctance to allow a fast pace of appreciation so expect plenty of FX intervention in the weeks and months ahead.

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Risk trade rally fizzles out

June 23, 2010 — Mitul Kotecha

The risk trade rally spurred by China’s decision to de-peg the CNY fizzled out. The realization that China will only move very gradually on the CNY brought a dose of reality back to markets after the initial euphoria. The fact that unlike in July 2005 China ruled out a one off revaluation adds support to the view that China will move cautiously ahead with CNY reform. In addition, renewed economic worries have crept back in, with particular attention on a potential double dip in the US housing market following a surprise 2% drop in existing home sales in May.

European banking sector woes have not disappeared either with S&P raising the estimate of writedowns on Spanish bank losses, whilst Fitch ratings agency noted that there is an increased chance of the eurozone suffering a double-dip recession. The net impact of all of these factors is to dampen risk appetite and the EUR in particular.

The UK’s announcement of strong belt tightening measures in its emergency budget did not fall far outside of market expectations. The budget outlined a 5-year plan of deficit reduction, from 11% of GDP in 2009-10 to 2.1% of GDP in 2014-15. The main imponderable was the response of ratings agency and so far it appears to have been sufficient not to warrant a downgrade of the UK’s credit ratings. Fitch noted that the “ambitious” plan ensured that the UK would keep its AAA credit rating. The emergency budget and reaction to it has been mildly positive for GBP, which has shown some resilience despite the pull back in risk currencies.

The recent rally in Asian currencies is looking somewhat overdone but direction will come from gyrations in risk appetite and the CNY rather than domestic data or events. Encouragingly equity capital flows into Asia have picked up again over recent weeks, with most countries with the exception of the Philippines registering capital inflows so far this month, led by India and South Korea.

China’s CNY move may attract more capital inflows into the region, suggesting that equity capital flows will continue to strengthen unless there is a relapse in terms of sovereign debt/fiscal concerns in Europe. Nonetheless, central banks in the region will continue to resist strong FX gains via FX interventions, preventing a rapid strengthening in local currencies.

Although India and Korea have registered the most equity inflows this month, both the INR and KRW have had a low correlation with local equity market performance over recent weeks. In fact the most highly sensitive currencies to their respective equity market performance have been the MYR and IDR both of which have reversed some of their gains from yesterday. USD/MYR will likely struggle to break below its 26th April low around 3.1825 whilst USD/IDR will find a break below 9000 a tough nut to crack.

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Respite for the dollar

October 27, 2009 — Mitul Kotecha

Markets are increasingly discounting stronger than expected Q3 earnings.  Further gains in equities and risk appetite may be harder to achieve even if profits continue to be beat expectations, which so far around 80% of Q3 earnings have managed to do. Measures of risk such as the VIX “fear gauge” have highlighted an increasingly risk averse environment into this week.  The negative market tone could continue in the short term.

The USD has found some tentative relief, helped by the drop in equities and profit taking on risk trades.  The fact that the market had become increasingly short USDs as reflected in the latest CFTC Commitment of Traders’ (IMM) report in which aggregate short USD positions increased in the latest week (short USD positions numbered roughly twice the number of long positions), has given plenty of scope for some short covering this week.

The USD has even managed quite convincingly to shake off yet another article on the diversification of USD reserves in China.  The USD index looks set to consolidate its gains over the short term against the background of an up tick in risk aversion.  The USD index will likely remain supported ahead of the main US release this week, Q3 GDP on Thursday, but any rally in the USD is unlikely to be sustainable and will only provide better levels to short the currency.

Given the broad based nature of the reversal in risk sentiment with not only equities dropping but commodities sliding too, it suggests that high beta currencies, those with the highest sensitivity to risk will suffer in the short term.  These include in order of correlation with the VIX index over the past month, from the most to the least sensitive, MXN, AUD, MYR, SGD, NOK, EUR, CAD, INR, ZAR, BRL, TRY and NZD. The main beneficiary according to recent correlation is the USD.

EUR sentiment in particular appears to be weakening at least on the margin as reflected in the latest IMM report which revealed that net long EUR speculative positions have fallen to their lowest level in 6-weeks.  Whether this is due to profit taking as EUR/USD hit 1.50 or realisation that the currency appeared to have gone too far too quickly, the EUR stands on shakier ground this week.  EUR/USD may pull back to near term technical support around 1.4840 and then 1.4725 before long positions are re-established.

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Asian currencies on the up

September 30, 2009 — Mitul Kotecha

The third quarter of 2009 has proven to be another negative one for the US dollar.  Over the period the dollar index fell by over 4%.  The only major currency to lose ground against the dollar over this period was the British pound.  Most other currencies, especially the so called “risk currencies” which had come under huge pressure at the height of the financial crisis, registered strong gains led by the New Zealand dollar, Swedish krona and Australian dollar.  Although the euro also strengthened against the dollar it lagged gains in other currencies over the quarter.

Asian currencies also registered gains against the dollar in Q3 but to a lesser extent than G10 currencies.  Asian currency appreciation was led by the Korean won, Indonesian rupiah and Singapore dollar, respectively.  The under performer over Q3 was the Indian rupee which actually depreciated against the US dollar slightly.  The reason for the smaller pace of appreciation for most Asian currencies was due mainly to intervention by Asian central banks to prevent their respective currencies from strengthening too rapidly, rather than due to any inherent weakness in sentiment.

In fact, Asian currencies would likely be much stronger if it wasn’t for such FX interventions.  A good indication of the upward pressure on Asian currencies can be found from looking at the strength of capital inflows into local stock markets over recent months.  South Korea has registered the most equity capital inflows so far this year, with close to $20 billion of flows into Korean equities year to date but in general most Asian stock markets have registered far stronger inflows compared with last year.   

For the most part, balance of payments positions are also strong.  For example, South Korea recorded a current account surplus of $28.15 billion so far this year, compared to a deficit of $12.58bn over the same period last year.  This is echoed across the region.  Although surpluses are expected to narrow over coming months due mainly to a deterioration in the terms of trade, the overall health of external positions across the region will remain strong and supportive of further currency appreciation.  

The outlook for the final quarter of 2009 is therefore likely to be positive for Asian currencies, with the US dollar set to weaken further against most currencies.  Some risk will come from a potential reversal in global equity market sentiment but overall, further improvements in risk appetite will support capital inflows into the region.  Capital will be attracted by the fact that growth in Asia will continue to out perform the rest of the world and yet again only interventions by central banks will prevent a more rapid appreciation of Asian currencies.

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Is the Asian FX rally losing steam?

June 5, 2009 — Mitul Kotecha

Asian currencies appear to have lost some of their upward momentum over recent days.  Although the outlook remains positive further out, they are likely to struggle to make further gains over coming weeks.  One the one hand strong inflows into Asian equity markets have given support to currencies but on the other hand, data releases reveal only a gradual economic recovery is taking place, with continued pressure on the trade front as seen in the weakness in recent export data in the region.  Even China has been cautious about the prospects of recovery in the country.   

Almost all currencies in Asia have recouped their losses against the US dollar so far this year, with the Indonesian rupiah the star performer, having strengthened by over 11% since the start of the year.  More recently the Indian rupee has taken up the mantle of best performer, strengthening sharply following the positive outcome of recent elections.  The rupee has strengthened by around 3.5% since the beginning of the year and its appreciation has accelerated post elections.   

Much of the gain in the rupee can be attributable to the $4.4 billion of inflows into local equity markets over the last few months, a far superior performance to last year when India registered persistent outflows. Notably in this respect, the Philippines peso is set to struggle as foreign flows into local equities lag far behind other countries in the region.  Inflows into Phililipines stocks have been just $226 million year-to-date as fiscal concerns weigh on foreign investor sentiment.   

South Korea has been the clear winner in terms of equity capital inflows in 2009, with over $6 billion of foreign money entering into the Korean stock market.  Elsewhere, Taiwan has benefited from the prospects of growing investment flows from China and in turn equity market inflows have risen to around $4.3 billion supported by news such as the recent report  that Taiwan will allow mainland Chinese investors to invest in 100 industries.  Equity inflows into these currencies are far stronger than over the same period in 2008, highlighting the massive shift in sentiment towards Asia and emerging markets in general.

Unsurprisingly stock markets in Asia have been highly correlated with regional currencies over recent months, with almost all currencies in Asia registering a strong directional relationship with their respective equity markets.  Recent strong gains in equities have boosted currencies but this relationship reveals the vulnerability of currencies in the region to any set back in equities, which I believe could come from a reassessment of the market’s bullish expectations for Asian recovery.  

Central banks in the region have been acting to prevent a further rapid strengthening in Asian currencies by intervening in FX markets but a turn in equity markets and/or risk appetite could do the job for them and result in a quick shift in sentiment away from regional currencies. The Indonesian rupiah remains one to watch in terms of further upside potential, supported by the Asian Development Bank’s $1bn loan to Indonesia.   The outlook for the Indian rupee also looks favourable as post election euphoria continues.  Nonetheless, the gains in these and other Asian currencies have been significant and rapid and I believe there is scope for a pull back or at least consolidation in the weeks ahead.

Posted in Asia, central banks, China, Currencies, Economics, Economy, equity markets, India, Indian election. Tags: , , , , , , , , , , , , , , , , , , , . 1 Comment »
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