Not so straightforward

May 20, 2013 — Mitul Kotecha

To casual observers the global market picture look very good, reflective of an improving growth and earnings story; risk assets continue to rally as central banks keep the liquidity taps open. In reality the picture is not as black and white as the US economy appears to be doing better than most other major economies despite the impact of the sequester and tax hikes while other economies are in differing states of health.

Japan’s turbo charged stimulus measures have helped contribute to a solid GDP growth outcome in the first quarter and to the rally in risk assets but much needs to be done in terms of reforms. Indeed, the jury is still out whether growth recovery can be sustained (just look back at the growth spurts and subsequent declines following past stimulus).

Europe remains in the doldrums as the impact of austerity weighs heavily, with even the core economies facing growing economic pressures. It’s no wonder that the anti austerity backlash continues to grow. While Eurozone data this week may look a little perkier than usual, with gains in the May purchasing managers’ confidence indices and the German IFO business climate confidence survey (both good forward looking indicators) likely, the overall picture will remain one of contraction. All of this will be unhelpful for the EUR which looks set to test its year low around 1.2745 versus USD.

US outperformance is fuelling a rise in US bond yields and consequently a stronger USD as expectations that the Fed will want to taper off asset purchases sooner rather than later grows. Fed Chairman Bernanke’s testimony this week will therefore be closely regarded as clues are sought However, he is unlikely to suggest that the Fed is verging on any reduction in asset purchases. Although US data was mixed last week the recovery theme will continue this week, with housing data and durable goods orders set to record gains.

In Japan the highlight of the week is the Bank of Japan policy meeting. Given the aggressiveness of recent measures expect a pause from the central bank at this meeting although the JPY will remain under pressure as the US / Japan yield differential continues to widen in favour of the USD. Nonetheless, comments by Japan’s Economy Minister Amari emphasising the negative impact of a weaker JPY may help to slow the pace of JPY decline.

The general strength in the USD has contributed to growing pressure on many Asian currencies. Only the THB, CNY and MYR have recorded gains this year. Other currencies including the KRW, TWD, and SGD have been particularly vulnerable to a weaker JPY. A slower pace of JPY decline will help these currencies although the prospects of further monetary easing and regional tensions will dampen any upside in the short term.

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JPY selling momentum slows

February 19, 2013 — Mitul Kotecha

Markets have few leads to trade off following yesterday’s President’s Day holiday in the US. Nonetheless, caution appears to be settling in ahead of this weekend’s Italian elections, especially in Europe.

European Central Bank President Draghi’s address to the EU parliament did little to stir markets as he didn’t elaborate much on his post ECB press conference in February. The most notable comment was that he urged the G20 to have very “strong verbal discipline” on talking about currency movements.

Despite the Italian election caution most risk measures appear to be well behaved. Equity volatility has continued to drop and gold prices have stabilised following the recent sharp decline. The highlight of the data calendar today is a likely gain in the February German ZEW survey.

Currency markets are rangebound but it is notable that USD/JPY has struggled to sustain gains above the 94.00 level, with upward momentum in the currency pair appearing to fade. Comments by Japan’s Finance Minister Aso that the government was not considering changing the central bank law at present or buying foreign bonds helped to dampen USD/JPY.

Although the G20 meeting effectively gave the green light for further JPY declines, a lot is in the price in terms of policy expectations and any further JPY weakness is likely to be much more gradual. USD/JPY 94.46 will offer strong resistance to further upside.

Asian currencies continue to deliver a mixed performance, with JPY sensitive currencies including SGD, KRW and TWD remaining on the back foot. The SGD is the most highly correlated Asian currency with JPY, with a high and significant correlation between the two. Any further drop in JPY will clearly bode badly for SGD but the inability of the JPY to weaken further may help to moderate pressure on the SGD in the near term.

Although the KRW has rebounded over recent days one risk to the currency is continued outflows of equity portfolio capital. South Korea is one of the only countries in Asia to have recorded outflows (around USD 1.2 billion year to date). However, this month the outflow appears to have reversed, with around USD 500 million in inflows registered month to date. In part the outflows of equity capital from South Korea in January reflected concerns about North Korea. Such concerns have receded but the risks remain of more sabre rattling and/or more nuclear tests from the North.

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Sell USD / Asia FX on rallies

January 9, 2013 — Mitul Kotecha

The biggest move this year appears to have come from the VIX ‘fear gauge’ which has dropped sharply contributing to an overall improvement in risk appetite. Although the VIX dropped further overnight equity sentiment overall continues to sour as fiscal cliff euphoria faded further and markets brace for the reality of likely protracted negotiations to raise the debt ceiling and avert huge spending cuts.

Caution over a plethora of fourth quarter earnings reports over coming weeks is also limiting upside for risk assets. Economic drivers were thin on the ground overnight but weak German exports data (which likely contributes to an overall decline in GDP in Q4) an increase in Eurozone unemployment and rumours of a French ratings downgrade did not help.

In the US the news was a little better as small business confidence reversed its sharp November drop. A limited data slate today will leave markets focussed on upcoming earnings, with consensus estimates for Q4 at a relatively low 2.9% QoQ.

Asian currencies have registered mixed performances so far this year. Resistance from some Asian central banks, notably Korea, has limited the appreciation of currencies. The incentive to prevent further strength has increased especially as a key competitor the JPY has weakened.

Maintaining its robust performance over 2012 the PHP has been the best Asian FX performer so far in 2013 followed by the THB. Similarly the IDR has maintained its negative performance registered last year. SGD is also likely to underperform further as the currency finds itself being increasingly used as a funding currency for taking long positions in other Asian FX.

We note that risk appetite has a limited correlation with Asian currencies at present but firm capital inflows will continue to provide support, with a sell USD / Asia FX on rallies environment set to persist.

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CNY influence on Asian FX continues to grow

October 31, 2012 — Mitul Kotecha

Asian currencies remain generally well supported both by a softer tone to the USD in general as well as a stronger Chinese currency, CNY. Since the USD/RMB high of 6.3964 on 25 July the RMB has appreciated by around 2.4% vs. USD. This equates to an annualized pace of appreciation of around 6.2%. The RMB is unlikely to continue to strengthen at such a rapid pace and could even be prone to a softer tone into year end.

Potential renewed weakness in the CNY could presage downside risks to Asian currencies. Also worth noting is the fact that equity portfolio capital inflows to Asian have slackened over recent weeks (Indonesia, Philippines and Taiwan registered outflows over October), a factor that could also pose risks to Asian currencies.

The influence of the RMB on Asian FX has continued to grow. Correlations or sensitivities between Asian currencies and the CNY remain are stronger than Asian FX sensitivities to USD movements. The implication is that USD index gyrations are having less influence on Asian currencies.

The most correlated currencies with the CNY are KRW, SGD and TWD although all Asian currencies with the exception of the INR register statistically significant correlations with the movements of USD/CNY. Notably our quantitative models show that the KRW, SGD and TWD are overbought relative to their short term fair value estimates.

While the USD is still influential in driving some Asian currencies several currencies including KRW, CNY and IDR do not possess a statistically significant sensitivity to the USD over the past 3-months. Should the CNY undergo renewed weakness it will mean that the currencies noted above namely KRW, SGD and TWD will be the most vulnerable to weakness given their high sensitivity to CNY.

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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.

Posted in Asia, Currencies, Economics, Economy, emerging markets, FX, India, Interest rates, Monetary Policy, Singapore, South Korea. Tags: , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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