Asian currencies keeping their head in a world losing its own

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Financial markets have had much to digest in recent weeks and the calendar for the remainder of May and June is anything but light, with the Fed and ECB holding key policy meetings and legislative elections in both the UK and France.

Nevertheless, most major currencies have either been flat or appreciated against a slowly weakening Dollar in the past month, with only the high yielding Brazilian Real, Russian Rouble and Indian Rupee (INR) and Australian Dollar weakening by 0.5% or more.

Conversely, European currencies have outperformed, with in particular the Euro Nominal Effective Exchange Rate (NEER) up about 3.4% since mid-April – in line with my constructive near-term euro outlook.

Non-Japan Asian (NJA) NEERs have seen only very modest moves in the past month. Bar the Malaysian Ringgit NEER which is up about 1.1% and the INR NEER which is down about 1.7%, NJA NEERs have appreciated or depreciated by less than 1%.

The question is whether this relative calm in NJA currency markets is likely to become more entrenched or whether FX flows and/or central bank policy are likely to fuel greater volatility or see some currencies adopting a clearer direction.

As a starting point, I would again note that the pace of depreciation and appreciation in most NJA currencies tends to be confined to reasonably narrow ranges.

While this is partly a by-product of seasonal patterns in current account balances and the ebbs and flows in capital migrations, it also arguably reflects central banks’ desire and scope to control their currencies.

At this juncture I would conclude that few central banks – including the MAS and PBoC – face overwhelming economic reasons to markedly alter the paths of their currencies via the bias of FX intervention and/or interest rate policy.

There is however perhaps a case for Bank Negara Malaysia to favour a weaker or at least stable Ringgit NEER which has appreciated about 2.7% since mid-April.

 

FX markets enter June from a position of reasonable strength versus Dollar

Financial markets have had a lot to digest in recent weeks and the calendar for the remainder of May and for June is anything but light, with the US Federal Reserve (Fed) and European Central Bank (ECB) holding key policy meetings and legislative elections in both the UK and France (see Figure 1).

Olivier Debarres Graph 1

 

Nevertheless, most major currencies have either been flat or appreciated against a slowly weakening US Dollar in the past month, with only the high yielding Brazilian Real (BRL), Russian Rouble (RUB) and Indian Rupee (INR) and Australian Dollar posting losses equal or greater than 0.5% (see Figure 2).

Olivier Debarres Graph 2

 

The Brazilian Real has by far been the greatest underperformer, depreciating about 3% versus the Dollar. It has been pressured by the scandal engulfing President Temer and recent central bank policy rate cuts. Moreover, the price of Brazil’s main soft and hard commodity exports has fallen (soybean prices are down 13% since mid-February and iron ore prices are at a 7-month low) while the economy of the US – Brazil’s second largest trading partner – is seemingly running into headwinds.

Conversely, European currencies have on the whole outperformed (red bars in Figure 2) with in particular the Euro Nominal Effective Exchange Rate (NEER) up about 3.4% since mid-April (see Figure 3). This is broadly in line with my constructive outlook for the euro near-term (see French politics, UK macro data and possible GBP/EUR downside, 21 April 2017). The French presidential election (which kept out of power National Front leader Marine Le Pen and ushered in the most pro-EU of the presidential candidates), signs that eurozone growth is gaining momentum and recent comments from German Chancellor Merkel and Finance Minister Schaeuble that the euro is too weak have buoyed the common currency.

While I remain modestly bullish the Euro near-term, note that the Euro NEER has been treading water for the past six trading sessions, according to my estimates, and the ECB’s stance on its quantitative easing program will be key in shaping the euro’s medium-term path (see Politics suspected of interfering with economics and markets, 19 May 2017).

Olivier Debarres Graph 3

 

For all the talk of US President Trump facing potential impeachment, at best mixed US macro data and lingering question marks about how many more hikes the Fed will deliver this year, the USD NEER is down only 1.3% in the past month and still on a par with the level which prevailed on US presidential Election Day (see Figure 4).

Olivier Debarres Graph 4

 

Major currencies’ reasonably sedate performance is apparent when measured in NEER terms, as per Figure 6, and is all the more impressive given recent international political and economic developments which include:

  • French Presidential elections which have ushered in a rainbow-government led by centrist Emmanuel Macron;
  • Increasing noise about US President Trump facing possible impeachment;
  • Political instability in Brazil;
  • Falling commodity prices, including for crude oil with OPEC’s output cuts (announced at its semi-annual meeting on 25th May) falling short of expectations;
  • A potentially fractious G7 Summit (which starts today);
  • Weak economic growth in the US and UK in Q1. UK GDP growth was revised down to a paltry 0.2% qoq from 0.3% qoq, according to ONS data released on 25th May (see US, UK and global GDP growth update – Put the champagne on ice, 28 April 2017);
  • Moody’s downgrading China’s sovereign credit rating one notch to A1 (with a “stable outlook”); and
  • Signs that global GDP growth is losing momentum.

 

A GDP-weighted basket of Emerging Market (EM) NEERs has weakened only 0.6% in the past month according to my estimates, whether the Chinese Renminbi (CNY) is included or not. Even the magnitude of the Brazilian Real’s depreciation in the past month has remained in line with recent history (see Figure 5).

Olivier Debarres Graph 5

 

Non-Japan Asian currencies on the straight and narrow

In particular, Non-Japan Asian (NJA) NEERs have seen only very modest moves in the past month, as highlighted in green in Figure 6. Bar the Malaysian Ringgit (MYR) NEER which is up about 1.1% and the INR NEER which is down about 1.7%, NJA NEERs have appreciated or depreciated by less than 1%.

A pick-up in NJA export growth in recent months has provided some support to current account balances and central bank FX reserves, capital outflows from China have abated and NJA central banks have been able to maintain steady policy interest rates (the last NJA central bank to change its main policy rate was the Reserve Bank of India which cut rates 25bp in October 2016). In South Korea, the election of President Moon Jae-in on 9th May has restored some order to a fractious political landscape while concerns about North Korea’s military capabilities have for now seemingly abated.

The question is whether this relative calm in NJA currency markets is likely to become more entrenched or whether FX flows and/or central bank policy are likely to fuel greater volatility or see some currencies adopting a clearer direction. As a starting point, I would note – as I first did two years ago in Asian currencies still on the straight and narrow (15 May 2015) – that the pace of depreciation and appreciation in most NJA currencies tends to be confined to reasonably narrow ranges.

Figure 7 shows that a GDP-weighted basket of NJA currencies, excluding the Renminbi, has in recent years tended to appreciate/depreciate by no more than about 4% per month versus the Dollar and this pattern holds true for most NJA currencies, including the Renminbi.

Olivier Debarres Graph 6

 

Of course if we measure this basket in NEER terms the monthly fluctuations are even narrower (as the NJA NEERs are made up of other NJA currencies – Asian countries are often each others’ largest trading partners). A GDP-weighted basket of NJA NEERs has in recent years tended to appreciate/depreciate by no more than about 2.5% per month and again this pattern holds true for most NJA currencies, including the Renminbi (see Figure 8).

Olivier Debarres Graph 7

 

While this is partly a by-product of seasonal patterns in current account balances and the ebbs and flows in capital migrations attracted/dispelled by valuations, I would also argue that it reflect these central banks’ desire and scope to control and cap the pace at which their currencies gain or lose competitiveness and impact imported-inflation. Of course NJA central banks’ ability and willingness to manage their currencies, particularly when they are under depreciation-pressure, are conditional on a large number of domestic and international economic, financial and political factors and will vary from one country to another.

At one extreme, the Monetary Authority of Singapore (MAS) targets the Singapore Dollar (SGD) NEER as its main policy instrument and in recent years MAS has kept the monthly slope of SGP NEER appreciation/depreciation within roughly +/-2 % (see Figure 10). The SGD NEER is broadly unchanged from a month ago (see Figure 9), which ties in with MAS’ stated aim at its semi-annual policy meeting on 13thApril of keeping the SGD NEER stable within narrow bands.

 

Olivier Debarres Graph 8

 

The People’s Bank of China (PBoC) fixes the USD/CNY spot rate daily and finally acknowledged last year that the CNY NEER was an important policy variable. It should therefore perhaps come as no surprise that while the CNY has tracked the USD and as a result the NEER has weakened 3.5% year-to-date (see Figure 11), the pace of CNY NEER depreciation remains well contained (see Figure 12).

 

Olivier Debarres Graph 9

 

At this juncture I would conclude that few central banks – including the MAS and PBoC – face overwhelming economic reasons to markedly alter the paths of their currencies via the bias of FX intervention and/or interest rate policy. Figure 13 summarises some of the key variables likely to influence central bank thinking, including GDP and export growth, core inflation and the level of FX reserves while Figure 14 summarises the current stance of exchange rate and interest rate policies.

Green boxes point to a possible incentive/need to tighten monetary policy because real policy rates are low by historical standards, the currency is weakening, GDP and/or export growth is robust, inflation is high relative to its multi-year range and/or central bank FX reserves are already high and/or rising. Conversely, red boxes point a possible incentive/need to loosen monetary policy because real policy rates are high by historical standards, the currency is appreciating, GDP and/or export growth is weak, inflation is low relative to its multi-year range and/or central bank FX reserves are already low and/or falling.

 

Olivier Debarres Graph 10 (2)

 

Olivier Debarres Graph 11 (2)

 

Bank Negara Malaysia may have a case to lean against Ringgit appreciation

There is perhaps a case for Bank Negara Malaysia (BNM) to favour a weaker or at least stable Malaysian Ringgit (MYR). The MYR NEER has appreciated about 2.7% since mid-April (see Figure 15) and is currently appreciating at a monthly rate of over 1% (in the top half of its historical range – see Figure 16), central bank FX reserves remain modest despite their recent increase and core CPI-inflation is low by historical standards (even if headline inflation is high).

 

Olivier Debarres Graph 12

 

The USD-value of merchandise exports rose at a robust quarter-on-quarter annualised rate of 23.6% in Q1 2017 (see Figure 13). However, since end-March the USD-price of crude oil (about 7% of Malaysia’s merchandise exports) has fallen about 3.4% which is likely to counter (from an export-revenue perspective) the 5% increase in the price of palm oil (5% of exports), as per Figure 17. The price of Liquefied Natural Gas (LNG) – about 6% of Malaysia’s exports – has been broadly stable in the past two months.

Therefore, BNM could conceivably opt to accumulate further FX reserves and support the competitiveness of electronic and electrical exports (about 33% of total exports) without little immediate concern about imported inflation, by intervening in the FX market to stop (or even slow) Ringgit appreciation. In a more extreme scenario BNM could in my view weaken the Ringgit, causing the month-on-month rate of change in the MYR NEER to eventually turn slightly negative.

 

Olivier Debarres Graph 13

 

Olivier Desbarres

Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.

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