Asia | Emerging Markets | FX
Risk is on
The risk rally in markets continues. Some of this is due to optimism around the reopening of economies around the world, especially the US. This should see economic activity pick up and a return of some normality. So far, we have yet to see second waves of COVID cases in any major economy, which has helped fuel the optimism.
It also helps that the European Union (EU) appears to be going down the path of sharing fiscal risk across the bloc in the form of the EU Recovery Fund. This has seen the euro strengthen and Italian spreads narrow (Chart 2).
Battered FX Bouncing Back
In FX, the biggest beneficiaries of this backdrop have been previously battered currencies such as the Brazilian real and the South African rand. Asian FX, meanwhile, has been more stable. The best performers have been the Indonesian rupiah (IDR) and Thai baht (THB, Chart 1). Nevertheless, even with stable currencies, returns can be captured through the carry earned on buying higher interest rate FX futures and selling lower interest rate FX futures.
Focusing on Asian Carry Trades
In Asia, the high-yielders are IDR, INR and PHP, while the low-yielders are TWD, JPY and SGD. A basket of these currencies – long IDR, INR, PHP and short TWD, JPY, SGD – has delivered returns of 0.5% over the past few weeks, and over 2% over the past month (Chart 3). In the current positive risk environment, we would expect FX carry trades to perform well. A carry basket, or individual Asian FX carry trades such as long INR/short TWD or long IDR/short SGD, could therefore deliver positive gains.
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
Risk is on
The risk rally in markets continues. Some of this is due to optimism around the reopening of economies around the world, especially the US. This should see economic activity pick up and a return of some normality. So far, we have yet to see second waves of COVID cases in any major economy, which has helped fuel the optimism.
It also helps that the European Union (EU) appears to be going down the path of sharing fiscal risk across the bloc in the form of the EU Recovery Fund. This has seen the euro strengthen and Italian spreads narrow (Chart 2).
Battered FX Bouncing Back
In FX, the biggest beneficiaries of this backdrop have been previously battered currencies such as the Brazilian real and the South African rand. Asian FX, meanwhile, has been more stable. The best performers have been the Indonesian rupiah (IDR) and Thai baht (THB, Chart 1). Nevertheless, even with stable currencies, returns can be captured through the carry earned on buying higher interest rate FX futures and selling lower interest rate FX futures.
Focusing on Asian Carry Trades
In Asia, the high-yielders are IDR, INR and PHP, while the low-yielders are TWD, JPY and SGD. A basket of these currencies – long IDR, INR, PHP and short TWD, JPY, SGD – has delivered returns of 0.5% over the past few weeks, and over 2% over the past month (Chart 3). In the current positive risk environment, we would expect FX carry trades to perform well. A carry basket, or individual Asian FX carry trades such as long INR/short TWD or long IDR/short SGD, could therefore deliver positive gains.
Chart 1: Asia FX vs USD Changes
Chart 2: Risk Measures are Declining
Chart 3: Asia FX Carry is Performing Well
Watch US-China Tensions
The biggest cloud on the horizon is clearly escalating US-China tensions. The US has recently proposed or enacted various policies to curtail Chinese activities. These have ranged from the possible delisting of Chinese companies from US exchanges to limiting US government pension funds from investing in China, and even to potential sanctions on China for human rights violations. This has also come with the re-emergence of protests in Hong Kong.
Chinese markets have reacted negatively to these developments. Both Hong Kong and Chinese stock markets have also fallen over the past week. USD/CNH is breaching the highs seen last year (Chart 4). USD/CNH has now risen almost 5% since its January lows. We would be cautious in extrapolating this trend too much. For one, Chinese authorities will be keenly aware that too much CNY/CNH weakness could complicate trade talks with the US. Secondly, authorities may prefer a stable currency to signal political strength.
Chart 4: USD/CNH Reaching New Highs
INR Stable Despite Poor Data
With the impact of the COVID lockdowns set to weigh heavily on the data for some time ahead, policymakers across the region continue to extend support. The Reserve Bank of India announced an unscheduled 40bps rate cut in late May taking the policy rate to 4.0%, the lowest in two decades (Chart 5). A debt moratorium was also extended, with borrowers now given an additional three months to repay. This comes on top of significant liquidity support and targeted yield curve control already in place. The door remains open for further easing from the RBI, and, with the country witnessing one of the most severe and disruptive lockdowns worldwide, India looks set to record one of the worst economic contractions globally.
GDP data for calendar Q1 (FYQ4) released on Friday showed growth slowing to a better-than-expected 3.1% versus a revised 4.1% in the previous quarter. Recent forecast revisions by Fitch see India’s economy contracting by a huge 5% in the current fiscal year (compared with an average of 6.5% over the past five years). There is little scope for further fiscal stimulus after the 10% of GDP package announced earlier this month. But the details have significantly underwhelmed, with the true stimulus estimated at around just 1% of GDP. INR has shrugged off this weak data – helped by a likely smaller current account deficit and lower oil prices compared with last year.
KRW Under Pressure
The Bank of Korea is the other central bank in the region easing policy. Last Thursday’s policy meeting is saw the policy rate cut by 25bps to 0.5% as expected and the Bank’s projections for GDP growth and inflation lowered. Liquidity support via unlimited three-month repos is already underway, and the bank has pledged to do more if needed. A further supplementary budget is also expected next month to bolster the fiscal response. Low rates, plus a recent spike in COVID cases and China trade worries, could mean some near-term weakness in KRW.
Chart 5: Asia Policy Rates – INR, IDR, PHP
Chart 6: Asia Policy Rates – KRW, TWD, THB
THB Strength to Continue
Monetary stimulus was also extended in Thailand in May with the Bank of Thailand cutting the policy rate by 25bps to an all-time low of 0.5% (Chart 6). The tourism and export-dependent economy is expected to contract more thank 5% this year with the recent strength in the Baht not helping. However, with economies re-opening worldwide, investors are now likely to focus on potential upside risks to the tourism sector. The currency was Asia’s best performing last year, gaining more than 7% versus the USD, and in the past month has gained nearly 2%, reversing some of the weakness earlier in the year. THB strength could continue as activity picks up.
Central Bank Helping IDR
Bank Indonesia was the outlier with the policy rate left on hold at 4.5% at its recent meeting versus expectations for a 25bps rate cut. Earlier currency weakness was a factor in the decision with the central bank keen to consolidate the recent recovery after the protracted weakness in March. This should likely support IDR.
Benefitting From Earlier Manufacturing Weakness
While economies across Asia are undoubtedly on course to record some of the worst recessions on record, the slump in global trade and IP seen through much of the last two years could now prove beneficial. The region’s manufacturing-intensive economies are relatively well positioned to bounce back, potentially offsetting some of the demand destruction from the COVID lockdowns.
April IP data out in Taiwan last week were reported at a better-than-expected 3.5% YoY (with electronics continuing to hold up), while for Singapore the 13% YoY gain in IP contrasts with expectations for a decline. The government nevertheless sharply revised its growth projections lower, with the Singaporean economy now expected to contract between 4-7% this year, versus the earlier expectation for a decline of 1-4%. South Korean IP data, by contrast, were worse than expected with output shrinking 4.5% YoY versus expectations for only a small decline.
May PMIs Point to Strength
This week’s manufacturing PMI data have also shown strength in Asia. China was the only country globally recording growth in output, with a 50.7 reading in the Caixin PMI, and the monthly pickup was the fastest in nine years. South Korea and Taiwanese PMIs inched down slightly from April but remained significantly higher than in other regions at 41.3 and 41.9 respectively. Thailand is now similar with a bounce back to 41.6 in May. Indonesia also ticked up but remained sub 30 reflecting differing timing on the lockdown. Data for Singapore are due on Wednesday and expected to show improvement from the sub 30 reading in April.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)