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Improved risk appetite lifts Asian currencies
Tamara Henderson Director, Currency and Rates Strategy, Asia, ANZ Bank
14-12-2009
ATI ASIA2010 Magazine
SINGAPORE – The global economy stabilised in Q1 2009, from which point improved risk appetite has lifted the currencies of emerging Asia (AXJ), particularly the Indonesian rupiah.
Looking ahead to 2010, we broadly expect the currencies of the region to experience further gains, buoyed by the normalisation of foreign discretionary demand, which we anticipate during the latter part of 2010. Those AXJ currencies with larger exposures to discretionary foreign demand stand to benefit most, especially the Korean won.
However, the road ahead is unlikely to be a straight path. Disappointment about the pace of recovery once the effects of stimulus measures and favourable base effects fade, or alternately, concerns that the unwinding of policy stimulus will derail the recovery, are likely to present temporary obstacles mid-year.
Positioning should also be monitored closely, owing to the risk that short USD positions against AXJ currencies become a “crowded” consensus trade.
On a structural basis, the reduction of global imbalances will buoy AXJ currencies at the expense of the US dollar. The G-20 (now the premier forum for international economic co-operation) and the G-7 have expressed keen support for balanced global growth.
Rebalancing will require expansion of domestic demand in Asia and increased saving in the US. Indeed, the meltdown in global financial markets during the later part of 2008, and the ensuing collapse of global economic activity, have already helped jump-start the rebalancing process. Going forward, as Asia relies more on itself – by spending more and diverting more of its capital toward its own growth potential – US importance will diminish, and the USD will weaken against AXJ currencies. As rebalancing is a multi-year process, cyclical dynamics must also be considered.
On a cyclical basis, current US macro-economic policy is inconsistent with the Obama Administration’s stated preference for a “strong” US dollar. Responding to concerns expressed by China and other BRIC countries about the value of their large US dollar reserve holdings, US Treasury Secretary Geithner has stated on several occasions that the Government favours a “strong” US dollar policy. However, a strong currency requires accordingly supportive macro-economic policy.
Although current US fiscal and monetary policy settings are a result of emergency measures to avert another Great Depression, they are nevertheless clearly USD negative – both on an outright basis, but also relative to the less-aggressive measures required in AXJ.
IMF projections suggest that the US current account deficit will narrow sharply from roughly five per cent of GDP in 2008 to 2.5 per cent in 2009. However, the US Congressional Budget Office expects the US budget deficit to balloon to a staggering 11 per cent of GDP in 2009 from three per cent in 2008.
By comparison, most current accounts in AXJ are in surplus, and several AXJ governments enjoy fiscal surpluses as well. The only country in AXJ with a comparable budget gap is India, at 10 per cent of GDP.
To be fair, US Treasury Secretary Geithner has promised to address the US budget deficit once an economic recovery is secured. However, meaningful progress on the US budget deficit is at least one, if not two-to-three, years away. US monetary conditions will also remain accommodative for some time to come.
Although emergency liquidity measures will likely be withdrawn in 2010, the desire to avert a jobless recovery means that the Fed will ensure that the price of money remains low. Moreover, benign inflationary pressures will allow the Fed scope to wait for a turn in the labour market.
Meanwhile, much stronger growth momentum in emerging Asia means that the negative US interest rate differential should persist.1
As such, without a profound and sustained improvement in US discretionary spending, macro-economic policy support for a “strong” USD will be largely lacking in 2010. In the meantime, investors – including central banks with large US dollar holdings – can be expected to continue to trim or hedge their exposure to US dollar weakness.
Absent a U-turn in risk appetite or co-ordinated FX intervention, structural and cyclical forces suggest the US dollar will continue to weaken against AXJ currencies for several more years. During sharp adjustments in risk appetite, the US dollar rallies as a result of safe-haven inflows, and weakens as cash is put back to work into higher-yielding (i.e. riskier) investments overseas.
Risk aversion from the escalating sub-prime crisis last year rescued the US dollar from historical lows as investors fled to the safest and most liquid market of all, US Treasuries. As such, a sustained pull-back in risk appetite associated with concerns about the recovery would be expected to provide support for the USD at the expense of AXJ currencies.
Indeed, we expect to see some disappointment in financial markets around Q2 and Q3 next year, once favourable base effects on growth have unwound, and the impact of stimulus measures has faded.
Another potential source of support for the US dollar could come from co-ordinated FX intervention. Key turning points in the US dollar have usually been associated with such “guidance” by policymakers.
The Plaza Accord marked the end of US President Reagan’s “strong dollar” policy and the USD peak in 1985. The Louvre Accord in 1987 signalled that the USD had weakened enough, but was only able to slow the descent of the USD until co-ordinated G-3 intervention in 1995 helped reinvigorate a multi-year uptrend in the USD – sustained by bouts of risk aversion during the Russia/LTCM crisis in 1998 and tech bust in 1999.
However, the risk of FX intervention to stem the decline in the USD appears low at this stage. Despite strong levels in the Euro and Yen, the G-7’s Communique in October focussed on China’s renminbi (CNY), supporting “continued appreciation . . . in effective terms” in order to “promote more balanced growth in China and in the world economy”.
Although official commentary from the sidelines of the G-7 meetings indicates support for a stronger US dollar among authorities from Japan, Canada and France, the message from the G-7 Communique is that Chinese – as opposed to American – exports present the greater threat. Indeed, the Euro and the Yen have strengthened much more against the currencies of AXJ over the past year.
Key Themes within AXJ in 2010
China – A predominate focus for AXJ currency markets will be the timing of the resumption of renminbi (CNY) appreciation. We continue to believe that USD-CNY will be held stable until a meaningful recovery in external discretionary demand takes place – not until the latter part of 2010. The G-7’s October Communique explicitly referenced China’s effective, not bilateral, exchange rate – reinforcing our view that USD-CNY will remain unchanged for many months to come.
Taiwan – The Taiwan dollar (TWD) should continue to enjoy support from a cyclical improvement in risk appetite as well as from structural forces stemming from the significant warming of ties with Mainland China. On the horizon are the signing of a financial Memorandum of Understanding, which spans banking, insurance, securities and futures sectors, and a trade agreement. However, relatively-rich valuations compared to the rest of emerging Asia and the developed markets present risk of a correction in local equity markets, and knock-on effects for the TWD.
Korea – Having been a dramatic under-performer during the flight-to-quality episode in the wake of the Lehman bankruptcy in September 2008, we expect the Korean won (KRW) to be a primary beneficiary once global discretionary demand improves in 2010. This year, the KRW has been outpaced by the Indonesian rupiah, which received an added boost from attractive yields and Bank Indonesia’s more delayed easing cycle.
Indonesia – The Indonesian rupiah (IDR) should continue to benefit on an outright basis from sustained risk appetite and attractive yields into mid-2010, but absent further credit rating upgrades, scope for further out-performance against the Korean won appears limited. The IDR is expected to come up against headwinds from inflation expectations more quickly. Also, as a more closed economy, the IDR stands to benefit less once foreign discretionary demand starts to recover.
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