What will Asian central banks do?
Global risk appetite nudges higher as “West Wing” versus “Yes Minister” plays out
Cinemagoers have in recent years been treated to the daft yet watchable Alien vs Predator and Superman vs Batman movie franchises but nothing compares to the Frankenstein-esque beasts of US and UK politics which have been thrust on voters both sides of the pond – a tragi-comic blend of “the West Wing” versus “Yes Minister” with more twists and sub-plots than a John le Carré novel.
Global equities, currencies and bond yields have increasingly been beating to the drum of the latest national and state polls, with macro data playing second fiddle for the time being. Risky assets, including equities and emerging market currencies, and in particular the Mexican Peso, have rallied in the past 48 hours on (albeit slim) evidence that Hilary Clinton has the edge over Donald Trump in opinion polls and early voting (see Figure 1). Conversely, safe haven assets including US Treasuries across the maturity spectrum, the Japanese Yen and gold have sold off as we head into the last day of campaigning.
However, while minute-by-minute political developments have whipped around US dollar crosses, the dollar Nominal Effective Exchange Rate (NEER) has been reasonably well behaved in the past month (see Figure 2). Moreover, the Canadian Dollar, which one would expect to benefit from a Clinton victory, has only posted modest gains in the past three sessions due in part to the 14% fall in crude oil prices in the past three weeks (see Figure 1). The Swiss Franc, typically a “risk-off” bellwether, has actually appreciated incrementally.
Non-Japan Asian (NJA) currencies have posted somewhat contrasting performances (see Figure 1). The drop in oil and gas prices is seemingly weighing on the Malaysian Ringgit while the Korean Won made up some ground after a five-week downtrend likely driven in part by Samsung’s product recalls. The Chinese Renminbi continues to grind weaker but for all the talk of currency weakness, the Renminbi NEER is still within a range (albeit at the lower end) in place since early September (see Figure 3).
FX markets not yet getting carried away
This more languid price action suggests that currency markets are not yet getting carried away and this seems sensible. This is ultimately a presidential race that remains too close to call with four credible scenarios still on the table:
- An outright and uncontested Clinton victory;
- An outright and uncontested Trump victory;
- A contested Clinton Victory – Trump has repeatedly stated that he would not accept the election result and, short of Clinton winning by an overwhelming majority, it is difficult to see why Trump would not be true to his word and legally contest the result.
- A contested Trump victory – this scenario has had little traction in the press but should Trump win by only a handful of electoral college votes, it is conceivable that Clinton could at the very least ask for recounts.
The 2000 presidential elections which pitted George W Bush and Al Gore are a helpful template for scenarios 3 and 4. Bush contested the initial election result – remember those infamous chads – which was eventually over-turned four weeks later. Bush was declared US President with 271 electoral college votes to Gore’s 266 despite having won a smaller 47.9% share of the national vote to Gore’s 48.4%.
So in effect there are not four, but at least six feasible scenarios depending on whether a contested election result would be overturned or not. Moreover, this uncertainty is compounded by the US concurrently running elections for 34 out of 100 Senate seats and all 435 seats in the House of Representatives. While Republicans are likely to retain control of the House of Representatives, it is conceivable that Democrats could regain control of the Senate with a net gain of five seats or more. This matrix of possible presidential and congressional election results will remain fluid for at least another 12 hours, if not longer, and plotting specific trajectories of asset prices under each scenario remains fraught with difficulty.
Price action tough to predict but what are Asian central banks likely to do (if anything)
However, we can try and ascertain whether and how NJA central banks may manage their currencies in coming weeks. The question is which NJA central banks, if any, have both the incentive – in terms of inflation and trade performance – and ability to at least slow any rapid currency depreciation or appreciation.
In a scenario whereby NJA currencies come under pressure, central banks of economies with low policy rates relative to inflation and robust exports could arguably be incentivised to at the very least temper any rapid and/or sustained currency depreciation, particularly if their FX reserves are sizeable. Conversely, in a scenario whereby NJA currencies start to appreciate, central banks with high policy rates relative to inflation and weak exports could arguably be incentivised to at least allow some currency depreciation, particularly if their FX reserves are modest.
- Overall I would argue that Bank Indonesia (BI) has the greatest incentive to allow some currency depreciation (and potentially cut its policy rate further) as inflation is low relative to history and to BI’s policy rate and Indonesia’s trade surplus has shrunk on the back of a sharp contraction in exports. At the same time BI still has only modest FX reserves with which to support the Ruppiah in the FX market.
- It is a not too dissimilar picture in India and for the Reserve Bank of India (RBI) in my view.
- Conversely, if either the Indian Rupee or Indonesian Ruppiah were under appreciation pressure, I would see scope for both BI and the RBI to intervene in the FX market to temper currency appreciation and build up FX reserves.
- In China, there is also some scope for the central bank to allow some further Renminbi depreciation
- In Korea, the central bank’s real policy rate is low in absolute terms and relative to history which on the surface would suggest that Bank of Korea (BoK) may be weary of Won depreciation. However the recent weakness in exports and narrowing of the trade surplus point to BoK being willing to tolerate modest and/or temporary currency weakness.
- In Taiwan, middling core CPI-inflation and robust export growth suggest that the central bank could conceivably opt to fade any sustained currency depreciation and maintain the gains which the Taiwan Dollar has made since the summer. It has the ability to do so given particularly large FX reserves.
Inflationary pressures still modest in Non-Japan Asia
Figure 4 shows that headline CPI-inflation is not high by historical standards in NJA economies, with perhaps the exception of Korea where headline inflation has gradually increased in recent months towards the high end of an admittedly narrow range. This picture is even more pronounced if we strip out energy and food prices. Core CPI-inflation is low or middling by historical standards in all NJA economies, including Korea (see Figure 5).
But this gives us only one side of the equation and we need to compare inflation to the prevailing central bank policy rates. Figure 6 shows that the central bank’s real policy rate (ex-post) – the nominal policy rate deflated by headline CPI-inflation – remains high in India and Indonesia despite recent rate cuts and in China. These central banks could arguably, all other things being equal, allow some currency depreciation and an overall loosening of monetary policy. Only in Korea is the real policy rate slightly negative. The picture is broadly the same if we deflate the nominal policy rate with core CPI-inflation as per Figure 7.
If we compare the real policy rate relative to history, it is again high in India and Indonesia and low in Korea (see Figure 8). It is high in Singapore but this is perhaps less relevant to the extent that the Monetary Authority of Singapore’s main policy tool is the Singapore Dollar NEER which is currently in a flat trading band.
A mixed performance for exports and trade balances
The trade surplus in the past three months has narrowed in China, Korea, Indonesia and Thailand and the deficit widened in India (see Figures 9 and 10). Conversely, the surplus has widened in Malaysia and Singapore. The surplus and deficit have in Taiwan and the Philippines, respectively, been broadly stable.
Broadly speaking NJA exports remain soft compared to a year ago but have recovered strongly in Taiwan, Malaysia and Philippines in recent months (see Figure 11). They have weakened significantly in Singapore, Indonesia and China. This would suggest that the central banks of these three economies would have the greatest incentive to allow their currencies to depreciate to more competitive levels.
India and Indonesia FX reserves up on the year but still modest
The USD-value of NJA central banks’ FX reserves has increased year-to-date, with the exception of China (see Figure 12) and they remain particularly large in Taiwan. Conversely, they are still modest in Indonesia and India which likely limits the ability of these two countries’ central banks to support their currencies in the FX market.
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.