Do you see US monetary policy tightening any time soon?
We think the US will definitely continue to err on the side of keeping policy easy, even though the debate on the durability of the global recovery will continue for the rest of the year. There are interesting parallels with 2002-2007 when easy [Federal Reserve] monetary policy contrived to give the US relatively high growth, the European Central Bank was constantly criticised for being behind-the-curve and carry trades were rife. Importantly, the strongest currency trend over that period was dollar weakness. So although some believe the dollar downtrend has raced too far ahead, we don't think that valuation warnings will be enough to stop the trend into year-end.
Which Asian currencies are you most positive about?
We are positive on the "cyclical" Asian currencies, such as the Taiwan dollar, the Singapore dollar, the Malaysian ringgit, the Thai baht and, most particularly, the Korean won. We believe a recovery in exports, a turn in local monetary cycles, and a likely resumption of renminbi appreciation will favour a greater accommodation by central banks of currency appreciation in the next three to six months.
What's the outlook for emerging Asian currencies in particular?
Our index for emerging Asian currencies, has been drifting sideways in a narrow 2% range since June. But if you look closely at individual currency levels, you can see three clear groups forming. The main underperformers are the Philippine peso and the Indian rupee, which despite sound balance of payments and growth outlooks are trading weak relative to their regional peers and external drivers.
The second grouping comprises the 'cyclical' emerging market currencies -- the Korean won, the Taiwanese dollar, the Singapore dollar, the ringgit and the baht -- which maintain strong correlations to equities and the dollar, albeit, in very tight ranges.
The Indonesian rupiah sits alone as an 'outperformer' and remains popular for its carry. The central bank is also disinclined to intervene against it.
While we have a constructive view on regional FX as a whole, we are most positive on the 'cyclical' group and, within that group, we would be most overweight the Korean won.
Are we seeing any evidence of central bank activity to cap currencies?
During the past five months we have seen some lacklustre price action that could be attributed to the presence of central banks intervening to cap the strength of their currencies. Since this fitted with an overall policy of monetary easing, and came after a collapse in exports and gross domestic product growth, the resulting expansion of money supply was not an immediate concern. But we believe a recovery in exports, a turn in local monetary cycles, and a likely resumption of renminbi appreciation will be drivers of a slight shift in intervention policies, in favour of greater accommodation of currency appreciation in the next three to six months.
Where do you see export growth headed?
Exports have been picking up for several months now, initially driven by China, but now reviving broadly as the G2 inventory cycle picks up steam and GDP growth rates turn positive. However the more widely watched year-on-year growth numbers will turn clearly positive from November to December, and will then climb quickly into double digits as negative base effects from the post Lehman collapse roll off.
Who do you think will move first on rates? Will the Fed lead the charge?
We expect most Asian central banks to start hiking rates from the first quarter or second quarter of next year, several months ahead of any tightening by the Fed. Our economists tell us that a lower output gap vis-à-vis the US, greater sensitivity to food and fuel price inflation and concerns about excess liquidity fuelling asset price bubbles make this highly possible.
Local market rates have started to drift higher in response to higher month-on-month inflation prints and some hawkish commentary by central banks. This is closing the gap with US interest rates, especially in the low-yielding currencies such as the Singapore dollar, the Taiwan dollar, and the Malaysian ringgit. Interestingly, the Singapore dollar, the Korean won and the ringgit are now firmly 'positive carry' currencies, soon to be joined by the Taiwan dollar.
Do you expect to see any policy shifts in China in favour of renminbi appreciation?
We believe inflation in China will rise faster than in other major economies, justifying rate hikes starting possibly from March 2010. In the 2006-08 tightening cycle, China guided market rates higher and the currency stronger almost simultaneously. We believe we are fairly close to a policy shift in favour of allowing a modest (4%-5%) pace of appreciation in the renminbi versus the US dollar, and expect non-deliverable forward currencies to soften further in the run-up.
What would be the impact of renminbi appreciation on other Asian currencies?
A strengthening renminbi would encourage other central banks to accommodate stronger currencies as well. As such, over the next three to six months, we expect stronger Asian currencies versus the US dollar. The most likely scenario is of the US dollar/Asia entering downward-drifting ranges as central banks gradually scale back their bids for dollars.
What do you see as the major risks to you currency views?
There is a risk that the US and China 'double-dip' on a shorter than expected inventory cycle and continued weakness in consumer demand. Also, if monetary tightening by Asian central banks is seen as premature by the markets, then it would trigger a sell-off in local equities and lead to capital outflows and, consequently, weaker currencies.