Asia FX Outlook – Why INR Continues To Defy Gloomy Outlook

– CNY appreciation to continue despite mixed signals on recovery

– C/A dynamics support INR, but economic outlook remains weak

– Gloomy data (excluding on housing) leaves KRW lagging

– Ongoing intervention caps TWD upside

– SGD stability key as economy starts to rebound

– THB under pressure on political upheaval

Vaccine Hopes and EU Recovery Fund Buoy Risk Sentiment

Asian currencies have continued to strengthen in recent weeks as hopes of a COVID vaccine alongside an agreement on coordinated fiscal stimulus in Europe buoy risk sentiment (Chart 1). The euro is now trading at its strongest level against the USD in around 18 months, and the broad dollar index is back at levels last seen in early March. New daily highs in COVID cases in several countries have had no material market impact since renewed nationwide lockdowns are unlikely and mobility data continue to point to a broad normalisation of activity globally, albeit with some pockets of weakness.

The Indian rupee has remained one of Asia’s best performing currencies this month, while TWD’s appreciation trend has been curtailed with the central bank increasingly intervening to leave the currency trading within a tight range (Chart 2). The Chinese renminbi has also performed reasonably well with the currency briefly sub 7/USD for the first time since March, although it has since weakened slightly. PHP has also strengthened, while the Indonesian rupiah and Thai baht are outliers with both currencies weakening by more than 2% MTD. Currency strength in most of Asia has been broadly in line with strong gains across most Asian stock markets, with markets in the region outpacing both major global indices and others in EM this month.

Second quarter GDP data releases have produced no major surprises so far; China’s headline reading was stronger than expected and Singapore’s a bit weaker. But the composition of growth and underlying strength of the recovery matter more than exact GDP numbers given the large swings. Chinese data raised some concerns in that regard, with consumption remaining sluggish. Coupled with efforts to rein in the earlier sharp rally in the stock market, optimism over China’s recovery has eased back from a few weeks ago.

Next US Stimulus Package in Focus

With the EU summit now concluded, attention will turn to the prospect of a third US stimulus package. A possible extension to the $600/week unemployment payments (currently due to expire at the end of the month), cuts to payroll taxes, and school funding will all be debated in a package that looks set to amount to around $1tn. This comes on top of $3tn in earlier fiscal stimulus, an already large 15% of GDP. Further monetary stimulus is unlikely in the US or Europe near term given the significant easing already in place, leaving US Treasury yields likely to remain at the current low levels and rate differentials supportive of Asia’s high yielders. Ongoing US-China tensions will remain an important factor in global risk sentiment. And, while we do not rule out a further escalation, particularly given the US decision to close China’s consulate in Houston, our base case remains for more rhetoric than concrete action.

CNY Appreciation Continues Despite Equity Correction

The Chinese economy has comfortably avoided a technical recession, leaving it one of the few globally that is likely to do so. Second quarter GDP rebounded by a higher-than-expected 11.5% QoQ non-annualised (after falling by a revised 10% in Q1), bringing the YoY rate to 3.2%. But despite this positive surprise on the headline reading, ongoing tensions with the US, concerns over the underlying strength of the Chinese recovery, and waning enthusiasm for the stock market rally have dampened sentiment.

One concern is the ability of Chinese consumers to offset what is likely to be subdued external demand for some time ahead. Retail sales disappointed in June with a contraction of 1.8% YoY versus an expectation of a small gain. While this is still an improvement from the -2.8% YoY reading in May, durable consumption (proxied by passenger car sales) dropped back from the May high, and consumer confidence remains below pre-COVID levels. Given consumers remain cautious, China’s ‘proactive and impactful’ fiscal stimulus will be crucial in supporting the domestic economy through infrastructure investment. Fixed asset investment data show improvement in June, but the wider fiscal stimulus is difficult to track in full on a high-frequency basis. Monthly budget data show the deficit up 18.4% YoY through April (12-month rolling basis), but this only covers part of the public sector. Official projections are for a 0.8pp deterioration in the deficit/GDP ratio this year (from 2.8% in 2019 to 3.6% this year). But the consolidated budget deficit is expected to widen from 4.9% of GDP last year to 11.2% in 2020, according to Fitch estimates. Such a large swing in the fiscal position is more in line with that expected elsewhere and should provide a significant contribution to GDP growth this year.

Expectations over infrastructure investment are boosting stocks in sectors such as construction. The CSI300 has lost around 3% since the 13 July high, after an initial drop of around 7%, and bond yields have dropped back sub 3%, reflecting unease over the economic and geopolitical outlook. But a sharp decline in shares of the country’s largest listed company, Kweichow Moutai, following government criticism over alleged corruption, was another factor dragging the index lower (Chart 4). Despite the correction, the Chinese stock market remains up around 13% MTD, far outpacing the 5% gain in the S&P or any other major market globally.

The earlier equity correction was not reflected in the currency, with the yuan briefly dropping sub 7/USD for the first time since March. While the currency has lost ground in recent days, so far this month only INR and PHP have appreciated by more versus the USD than CNH. And, although US-China tensions will remain high and could well escalate further, particularly given the recent US decision to close China’s consulate in Houston on the grounds of economic espionage, prohibitive economic restrictions remain unlikely in the run up to November’s US presidential elections. As such, we expect the yuan will remain driven by fundamentals, leaving scope for further appreciation. Bond yields have dropped back sub 3% after the recent run up, but yield differentials remain supportive. The 1-year loan prime rate was left unchanged at 3.85% earlier this week, although further cuts to policy rates and reserve requirements cannot be ruled out if the recovery disappoints. Nevertheless, with China’s recovery in considerably better shape than elsewhere, we continue to see scope for currency strength and see USD/CNH lower from here.

Trade Surplus Buoys INR Despite the Worst Business Outlook Globally

While both India and China have seen recent currency strength, the economic outlook could not be more different. The tri-annual Business Outlook surveys released earlier this month by IHS Markit show India’s outlook as the worst globally, while for China companies are more optimistic than the global aggregate and optimism over future business activity is currently the highest in more than three years (Chart 5). Business activity expectations in India turned negative for the first time in the survey’s 11-year history with profits, employment and R&D all set to decline. The exceptionally poor business outlook largely aligns with the dismal economic data over the past several months, with India recording some of the largest declines in trade and IP globally.

That India recorded its highest-ever number of new daily COVID cases on Monday (40,425) also bodes badly for any near-term improvement in sentiment. The country has gradually lifted its strict lockdown, but renewed localised lockdown cannot be ruled out and full normalisation of activity remains some way off.

Ongoing negative news on the economy and virus containment failed to impede the stock market. But unlike the rally in Q2, which was driven by significant foreign inflows, July has so far seen modest outflows. Nevertheless, even without these capital inflows, India’s BoP position is undergoing a material improvement on the back of a lower oil bill and import compression. India’s trade balance swung into surplus for the first time in 18 years in June with exports down 12.4% YoY and imports contracting by a much larger 47.5%, leaving a repeat of the rare January-March C/A surplus a distinct possibility (Chart 6).

India’s very severe lockdown hampered data collection, leaving CPI releases for April and May suspended. The recent release of June retail inflation at 6.1% YoY (versus 5.84% in March) has raised questions over both consistency in the data and gaps in the detail. Given the uncertainties in the data (and WPI at -1.8% YoY) and the much wider macro challenges, June’s above-target reading is unlikely to be the determining factor in the 6 August RBI decision. Views are mixed on whether the RBI will cut rates again from the current 4.0%, but, even with a reduction in rates, INR will remain one of the region’s high yielders. Given the very poor macro outlook, we expect INR to trade within a narrow range and therefore consider it attractive as a carry trade.

CBC Intervention Masks an Ongoing Economic Rebound

End of day weakness continues to characterise TWD, pointing to ongoing intervention to offset what would otherwise be steady appreciation. Afternoon selling has repeatedly pushed the currency more than 0.4% weaker, leaving overall currency performance lagging others in the region over the past month (up 0.3% MTD). The currency has weakened slightly after hitting a two-year high in early July. But at around 29.5/USD the Taiwanese dollar remains close to levels last seen in April 2018 and is Asia’s second-best performing currency YTD, up 1.9%. And, with the NEER index above the +5% deviation band (3-year MA basis) for the past month, the likelihood for further intervention ahead remains high.

Currency strength is not, however, dampening export competitiveness, with June export orders up by 6.5% YoY – the fastest gain since 2018 and positive for a further rebound in the trade data (Chart 8). Electronics and ICT continue to be an important driver (orders of these components are up 7.3% and 17.1% YoY respectively) thanks to the shift towards working from home under COVID. Overall, Taiwan’s C/A dynamics are set to remain supportive for TWD appreciation, leaving the CBC trying to lean against a trend rather than simply volatility (Chart 7).

Strong demand for electronics was also reflected in the Q2 results for TSMC, with net profits up 81% YoY and revenues up 29%. The stock is trading at a record high and has helped push the Taiex up by almost 7% so far this month. Taiwan also remains the only country in Asia where foreign equity inflows are positive MTD ($1.42bn), providing an additional support to the currency. It also reflects the more robust domestic recovery versus other countries in the region, with monthly data pointing to a much shallower dip in Q2 GDP than in Korea or Singapore.

With Taiwan’s 10-year yield dropping to an all-time low of just below 0.44% earlier this week and central bank intervention capping further appreciation, short TWD positions versus high yielders such as INR continue to be our preferred play.

Monetary Stimulus in South Korea is Fuelling Rising House Prices

Relative to others in the region, performance of the Korean won has been more volatile. Month-to-date the currency is 0.6% stronger; but this has not made up for earlier weakness, and the currency remains among the worst performing in Asa YTD, down more than 3% versus the USD. Korea has benefitted from improved risk sentiment over the past month, with the KOSPI up around 5%. Again, however, this is less than nearly all other major Asian markets, and, unlike Taiwan, foreign equity flows have been outwards for the past month.

KRW underperformance reflects Korea’s sluggish economic recovery despite new COVID cases being at their lowest level for one month. The Bank of Korea maintained its accommodative stance at the mid-July policy meeting, citing ongoing weakness in domestic demand and expectations for inflation to remain around the current very low levels. In May the BoK projected the Korean economy would contract by just 0.2% this year, but this is now expected to be lower. Second quarter GDP data were reported at a weaker-than-expected -3.3% QoQ (consensus at -2.4% QoQ) leaving the YoY rate at -2.9% and pushing Korea into its first recession since 2003.

Governor Lee Ju-yeol acknowledged rising house prices (up 4.6% YoY in Seoul in June, Chart 9) but confirmed that the monetary policy outlook remained contingent on broader trends in growth and inflation, and not housing. While the policy rate was left on hold at 0.5% as expected, the comments were viewed as dovish. The governor confirmed further use of non-standard tools if needed but provided no details on further government bond purchases.

Latest economic data has reinforced the gloomy outlook. Preliminary trade data for July show the contraction in both exports and imports deepening, at -12.8% YoY and -13.7% respectively, crimping Korea’s export-dependent economy further. Current account dynamics were already under pressure, with the surplus narrowing sharply in recent months; and despite imports currently falling faster than exports, this is unlikely to offset the negative trend. And with few positives for the won, we reiterate our call for KRW/USD to head lower from here.

Stable Currency ‘an Anchor of Confidence’ for MAS

Singapore’s 41.2% QoQ saar decline in second quarter GDP (-12.6% YoY) is set to be one of the largest globally (Chart 10). The strict lockdown measures in place from April to early June brought much of the economy to a standstill, with all sectors registering double-digit contractions on a QoQ basis. Manufacturing suffered less than other sectors thanks to demand for biomedical manufacturing (pharmaceuticals). MAS estimates that 12% of Singapore’s economy was at the epicentre of the COVID impact, split between construction, travel and consumer-facing domestic services. But other sub sectors of the economy were also highly impacted. A sharp rebound in June non-oil exports (up 16.1% YoY) suggests the economy is starting to recover, and IP data due later in the month are also expected to show a sharp improvement.

MAS confirmed in its recent annual report that it will ‘keep the exchange rate stable, to provide an anchor of confidence’. Limiting deflationary pressures (headline CPI stands at -0.8%) remains the stated rationale, with the main COVID response coming via large fiscal support. Unsurprisingly, S$NEER is therefore virtually unchanged over the past month and will remain so until at least the October policy statement. MAS seem content that the shift to a 0% appreciation band and lowering of the midpoint of the band, alongside numerous other measures such as providing USD liquidity, are sufficient to ensure the maintenance of monetary and financial stability. Versus the USD the currency has appreciated by around 0.6% MTD, reflecting broad USD weakness. A weak USD and a risk-on environment leaves scope for further modest appreciation; however, given the ongoing underperformance of the stock market and S$NEER stability, the currency will underperform against peers. And as a low yielder we continue to prefer SGD (or TWD) as a carry trade to the high yielders.

THB Under Pressure Given Political Turmoil

THB has been one of the worst performers in Asia since the start of the month, down 2.4% versus the USD, amid improvement in risk sentiment and erosion of the country’s trade surplus. Bank of Thailand governor, Veerathai Santiprabhob, noted that recent THB weakness was due to capital outflows on the back of economic and political concerns with resignations of key cabinet officials (including the deputy prime minister and finance minister), increasing uncertainty around economic policies. But recent THB weakness is likely to provide some relief to the BoT, which noted at its June meeting (where rates were left unchanged at 0.5%) that baht strength ‘could affect the economic recovery’. For much of 2019, THB price action defied BoT attempts to curb its strength via looser capital controls. Current conditions suggest further upside for THB, but a potential worsening in risk sentiment due to renewed global fears of a second wave of cases could turn this around. The spread of Covid-19 in Thailand appears to be relatively contained, with the country reporting no new locally transmitted cases in over six weeks.

July PMIs and US and Euro Area GDP Data in Focus Over the Coming Weeks

Aside from news over the US fiscal package, the market focus over the coming weeks will remain on second quarter GDP data and the information this provides on the subsequent rebound. China is the only major economy to release data so far, with the US and Euro area data due at the end of the month. Consensus for the US stands at -33.4% QoQ saar, and for the Euro area this stands at -12.4% QoQ. As Euro area GDP data are released on a non-annualised basis, the US headlines will look much worse than for Europe. In reality, though, it is the Euro area that is expected to report the larger contraction. On a more comparable YoY basis the Euro area GDP expectation stands at -15.0% versus -10.3% for the US. Taiwan’s Q2 GDP release is also expected at the end of the month, with a modest -0.5% YoY decline expected. Ahead of the GDP data flash, PMI estimates for July will be released across the major economies and are expected to confirm a further normalisation in activity through the start of the third quarter.

Caroline Grady is a Senior Researcher at Macro Hive. Formerly, she was a Senior EM Economist at Deutsche Bank and a Leader Writer at the Financial Times.

(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.)