Asian currencies face volatility from threat of US downgrade

As US politicians take posturing to new levels, we ask Deutsche Bank's Dennis Tan about what it means for foreign exchange markets.
Dennis Tan, Deutsche Bank
Dennis Tan, Deutsche Bank

How do concerns about the US debt ceiling and the possibility of more quantitative easing affect Asian currencies?
A US debt ceiling deal should be positive for global risk sentiment. Given that the US dollar is the primary funding currency for risk trades, however, any bounce in the US dollar after the deal will probably be short-lived, and we are likely to see the dollar quickly resume its downtrend alongside a rally in global equities. Asian currencies should strengthen against the US dollar in this scenario. 

If, however, a deal cannot be reached before the August 2 deadline, or is too small in size to prevent a ratings downgrade, we are likely to see a sharper fall in the US dollar, particularly against safe haven currencies like the Swiss franc, Japanese yen and precious metals. The reaction of Asian currencies in such a scenario will probably be complicated by cross-currents from risk aversion and equity outflows. We might not see outright weakness in Asian FX against the US dollar, but the currencies will likely prove more volatile. 

Beyond the short-term dynamics, we note that recent talks of, one, a possible downgrade for US ratings and, two, the need for another round of quantitative easing if the soft patch in the US continues, seems to have put Asian policymakers on alert against another surge in capital inflows into the region. Officials from various central banks around the region have started to again voice concerns after a long gap, and we could see renewed discussions around capital control measures in the region.

What about the euro — surely it’s set to depreciate given the continuing concerns over defaults in the eurozone. How does that play out with respect to Asian currencies?
Following the recent eurozone agreement on a debt relief programme for Greece, our expectation is that the euro will be characterised by range-bound trading in an environment of unresolved, albeit lower tail risks. It is likely that the highs and lows for the euro have already been set for the year.

Asian currencies have become increasingly resilient to the concerns around eurozone contagion. It appears that the offshore community continues to hold a high level of conviction in the Asia macro trade, potentially even pointing to a view of Asia as a safe haven in contrast to other beleaguered regions.

China’s FX market has gone from being non-existent to boasting more than $3 billion in daily turnover in spot and forwards. Is this just a one-way bet?
Broader market risk aversion has resulted in a somewhat weakened expectation of renminbi appreciation against the US dollar, but we are still bullish on the currency. Inflation remains high and China is allowing gradual appreciation of the yuan against the dollar, at a recent pace of 4% to 5% per annum. Offshore renminbi forwards, which we think are the cheapest way to access renminbi appreciation, are still pricing in 0.4% appreciation in the onshore spot.

Which other Asian currency do you expect will perform well, and why?
We see the Singapore dollar, the rupiah, the won and the ringgit doing well in the second half of the year.

Inflation remains quite high in Singapore, and we think that the Monetary Authority of Singapore will likely have to maintain a tight policy in October by allowing a gradual appreciation of the Singapore dollar nominal effective exchange rate.

Indonesia has seen strong FDI and portfolio inflows this year, even as commodity exports there are booming. Meanwhile, Bank Indonesia we think favours exchange rate over interest rates as a more effective monetary policy tool against inflation in the current scenario.

In Korea, the government is concerned over rising inflation. However, the BoK is constrained by the high level of household debt in hiking interest rates. Arguably then, the currency can play a larger role in countering inflation. 

We also think that there is some scope for the ringgit to play catch up to regional FX given the strength of Malaysia’s current account surplus, which has also benefited from high energy prices. Inward foreign direct investment in Malaysia has also been trending higher, while foreign interest in ringgit bonds remains quite strong.

So what currency in Asia are you most wary of, and why?
We are more neutral on the Thai baht, given that the currency has already caught up with the rally in other regional currencies after the elections. We do not suggest chasing the rally in the baht despite a pick-up in portfolio inflows after the elections. The current account in Thailand is one of the most vulnerable in the region to rising oil prices. The Bank of Thailand runs a policy of guiding the baht to move in line with trade partner currencies, and so the central bank will probably slow gains in the currency if the baht’s outperformance were to extend.

How should Asian corporates manage these FX trends?
The rationale for hedging FX risks remains strong as Asia’s currencies continue to re-price against the euro, US dollar and Japanese yen. The continued appreciation of the region’s currencies presents an exposure for the region’s corporations. But the mechanics of the FX market are also changing. Regulatory changes that are taking place in US and Europe — like the European Markets Infrastructure Regulation and the Dodd Frank Act in the US — will have a significant impact on how Asian FX markets are traded and in turn, how Asia’s corporations can choose to hedge their FX risks. Efforts to increase price transparency on certain FX derivatives and lower counterparty risk by requiring currently private, bilateral trades to be executed via public exchanges and cleared via a central clearing counterparty will likely result in higher hedging costs and will require a more considered FX strategy for corporates across Asia.

Disclaimer: The views expressed are those of the interviewee and do not necessarily reflect the official views of Deutsche Bank or its related entities.

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