Asia | COVID | Emerging Markets | FX | Monetary Policy & Inflation | Politics & Geopolitics
– TWD outperforms on foreign equity inflows, but intervention could limit further gains.
– KRW lags due to a subdued recovery.
– CNY remains stable to strong despite rising geopolitical tensions.
– Poor macro and RBI not enough to generate INR weakness.
– SGD follows global risk appetite.
Risk Volatility Takes Asian FX Along With It
Markets have been on a bumpy ride over the past two weeks. Ongoing policy stimulus and relaxation of COVID lockdowns continue to buoy risk appetite. But new COVID outbreaks in the US, Germany and China leave ongoing concerns that the global recovery could yet be derailed. A brief equity correction and bout of risk aversion pulled Asian currencies weaker in mid-June alongside other EMFX. But markets have since stabilized and a bounce back in activity data has, for now, allayed concerns over any material threat to the economic recovery.
USD strength from a fortnight ago has reversed, and markets have resumed their positive momentum. FX performance has not been uniform across Asia, however, with the Korean won and Indonesian rupiah lagging others in the region, both down 1% since 11 June. The Taiwanese dollar has been the outperformer with a small gain (Chart 1).
Asia Export Outlook Turning More Positive
While attention is focused on how quickly the global economy can bounce back from the COVID lockdowns, the overall magnitude of the decline continues to be marked lower. Updated IMF forecasts saw this year’s global growth projection reduced to -4.9%, from the -3% predicted in April. But for Asia’s export-orientated economies, this week’s WTO update – noting global trade avoiding the pessimistic scenario set out earlier in the year – should be welcome news. The WTO had assumed a trade elasticity to GDP growth in line with the GFC, but in fact the response looks to be lower. A sizeable policy response to the crisis, protracted declines concentrated in non-tradeable services and resilience in sectors such as electronics are key reasons for the more upbeat assessment.
Policymakers nevertheless remain cautious given the uncertainty over the recovery. Fed Chair Jay Powell told Congress last week that despite recent better-than-expected data on retail sales and unemployment, he expects the US economy will take several years to return to full capacity. And as the Fed shifts its focus away from large-scale asset purchases and towards credit to the nonfinancial sector, we see some risks to our bearish dollar call and by extension Asian FX. But with US yields firmly anchored, Asia’s high yielders should remain attractive.
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– TWD outperforms on foreign equity inflows, but intervention could limit further gains.
– KRW lags due to a subdued recovery.
– CNY remains stable to strong despite rising geopolitical tensions.
– Poor macro and RBI not enough to generate INR weakness.
– SGD follows global risk appetite.
Risk Volatility Takes Asian FX Along With It
Markets have been on a bumpy ride over the past two weeks. Ongoing policy stimulus and relaxation of COVID lockdowns continue to buoy risk appetite. But new COVID outbreaks in the US, Germany and China leave ongoing concerns that the global recovery could yet be derailed. A brief equity correction and bout of risk aversion pulled Asian currencies weaker in mid-June alongside other EMFX. But markets have since stabilized and a bounce back in activity data has, for now, allayed concerns over any material threat to the economic recovery.
USD strength from a fortnight ago has reversed, and markets have resumed their positive momentum. FX performance has not been uniform across Asia, however, with the Korean won and Indonesian rupiah lagging others in the region, both down 1% since 11 June. The Taiwanese dollar has been the outperformer with a small gain (Chart 1).
Asia Export Outlook Turning More Positive
While attention is focused on how quickly the global economy can bounce back from the COVID lockdowns, the overall magnitude of the decline continues to be marked lower. Updated IMF forecasts saw this year’s global growth projection reduced to -4.9%, from the -3% predicted in April. But for Asia’s export-orientated economies, this week’s WTO update – noting global trade avoiding the pessimistic scenario set out earlier in the year – should be welcome news. The WTO had assumed a trade elasticity to GDP growth in line with the GFC, but in fact the response looks to be lower. A sizeable policy response to the crisis, protracted declines concentrated in non-tradeable services and resilience in sectors such as electronics are key reasons for the more upbeat assessment.
Policymakers nevertheless remain cautious given the uncertainty over the recovery. Fed Chair Jay Powell told Congress last week that despite recent better-than-expected data on retail sales and unemployment, he expects the US economy will take several years to return to full capacity. And as the Fed shifts its focus away from large-scale asset purchases and towards credit to the nonfinancial sector, we see some risks to our bearish dollar call and by extension Asian FX. But with US yields firmly anchored, Asia’s high yielders should remain attractive.
FX Intervention Curbs Appreciation Pressure in TWD
Policy preference for weak currencies is an increasingly dominant force in Asian FX. Taiwan’s central bank governor Yang Chin-long confirmed last week that the bank intervened to stem TWD appreciation on the back of what he described as ‘huge’ inflows. No amounts were given, but the bank has intervened in fairly sizeable amounts in the past, with net $5.5bn through 2019 and with larger amounts in H2 offsetting selling in the first half of the year. Equity performance has been a clear driver, with the stock market up 6% since the start of the month and Taiwan recording $2.76bn in foreign equity inflows so far in June – more than anywhere else in Asia.
Despite CBC intervention, the currency remains over 1% stronger over the past month and is Asia’s second-best performing currency YTD after the Japanese yen. The CBC confounded expectations for a rate cut last week despite downgrading its growth and inflation expectations (now +1.5% and 0.01% respectively for this year). An expectation for accelerating domestic demand in H2 was the main rationale, and the latest data continue to point to the Taiwanese economy being in better shape than most others in Asia. May unemployment was reported at a better-than-expected 4.16%, and industrial production remained positive at 1.5% YoY versus large contractions expected across the region. Exports have also held up fairly well with the -1.3% YoY decline in May, by far the smallest in Asia.
Despite a more robust economy and rising real rates through ongoing deflation (CPI sunk deeper into negative territory in May at -1.2% YoY), further TWD appreciation remains unlikely. CBC intervention will cap further upside, and with deflation set to ease later in the year real rates will start to drop back. We therefore think that short TWD (and SGD) positions against higher interest rates currencies like INR could still be preferred.
Chart 1: TWD is the Region’s Outperformer
Chart 2: Asia FX Versus USD
INR Remains Stable Despite Poor Macro and RBI
The RBI has also been mopping up reserves to lean against currency appreciation. Estimates for intervention month-to-date stand at around $9bn, taking the total since May to around $18bn. This leaves INR the worst performing Asian currency YTD, down just over 6%. But the currency is broadly unchanged over the past several weeks.
Rather than concerns over competitiveness, the RBI looks to be building up firepower to act against future outflows. India’s COVID cases continue to spike, and the economy’s capacity to recover from what was one of the most severe lockdowns globally is uncertain. Moody’s cut India’s sovereign rating by one notch to Baa3 earlier this month, with negative outlook, leaving it one notch above junk and bringing it in line with both Fitch and S&P (the outlook on the latter rating is at stable). Any downgrade to sub-investment grade could trigger significant bond outflows and rupee depreciation.
Weak public finances and a sharp slowdown in growth ahead of the COVID crisis leaves India in a particularly weak position. The 50-60% YoY declines reported for April IP and exports tell us only that the economy was at a standstill, leaving May-June data crucial to gauge the likely pace of recovery. One complication is the increasing gaps in data collection. Inflation releases for both April and May have been missed, and the IP data collection covered a narrower set of inputs than normal. Proxy measures and telephone survey data are to be used to plug any gaps, but the reliability of these new measures is unknown. And, moreover, the impact of the COVID crisis on employment in India is likely to be very difficult to gauge.
Despite the weak macro backdrop and rising geopolitical tensions with China, foreign equity inflows have continued and are not too far behind Taiwan MTD (Chart 3). Combined with exporter dollar sales, the RBI has bought foreign currency to prevent what might otherwise have been an appreciating rupee. Given the political tensions and weak macro, we remain neutral on INR and consider it attractive as a carry trade.
Chart 3: India And Taiwan Have Seen Equity Inflows Month-to-date
Chart 4: India’s IP Collapse Has Been More Pronounced Than Others In The Region
RMB Resilient to Geopolitical Tensions
Escalating tensions with India and conflicting comments over the Phase 1 trade deal with the US have not done much to materially impact the yuan. Nor has the partial lockdown in Beijing in response to the latest COVID outbreak. The impact is, however, evident in declining air traffic (as well as in other mobility data such as TomTom, Chart 5) and has raised concerns over a possible interruption to the recovery. But, for now, the latest virus outbreak has not materially altered expectations on China’s V-shaped recovery. The Beijing restrictions are on a much smaller scale than the complete shutdown of Wuhan and key industrial areas earlier in the year.
Worries over the strength of the recovery may have been one factor keeping the PBoC on hold as it saves its firepower for a later date. The PBoC’s loan prime rate was left at 3.85% (1 year) and 4.65% (5 year) earlier this week as expected, with near-term easing set to come through reduced reserve requirements. RRs have already been cut several times this year as the central bank injects liquidity in an effort to prop up the economy (Chart 6).
We continue to see scope for modest appreciation of CNY. Both C/A dynamics and rate differentials are favourable, and geopolitical tensions, while undoubtedly important to monitor, do not look set to escalate further for now. The US has confirmed the Phase 1 deal remains in place, and recent threats on various other non-trade restrictions have eased back. We continue to expect CNH/USD to head higher.
Chart 5: Beijing’s Lockdown Can Be Seen in Declining Air Traffic
Chart 6: China’s RR Set To Drop Lower Given Worries Over The Recovery
Earlier KRW Strength Reversed
A weak macro backdrop and an ongoing COVID outbreak have caught up with the Korean won. KRW is now the worst performing currency in the region over the past two weeks, losing 1% against the USD. This is a sharp turnaround from the strong performance in early June and leaves KRW as the second-worst performing currency in Asia YTD after India. FX weakness is in line with stock market losses, with the KOSPI down 2% over the past two weeks (Chart 7). Selling looks to have come from foreigners, with Korea recording the largest net foreign equity outflows so far this month (exc. China) and for the second quarter also. Bonds flows have been positive but not by enough to offset the equity outflows.
Unlike in Taiwan, the domestic recovery is expected to be sluggish for some time ahead, and the Bank of Korea now expects the economy to stagnate this year. Preliminary export data for June also show a further sharp contraction, albeit with the pace of decline easing from the 23.6% recorded in May. And with the C/A surplus narrowing, this is another hurdle for the won. We reiterate our call for KRW/USD to head lower from here.
Chart 7: KRW Has Weakened In Line With The KOSPI
SGD Broadly Stable as Risk Recovers
SGD is trading broadly unchanged versus the USD compared with two weeks ago, recovering after the short bout of risk aversion that saw the currency weaken alongside global equities. And while currency performance will continue to be driven by global risk factors, attention remains firmly on the pace of recovery. The 40% YoY fall in April retail sales and 24% YoY fall in exports highlight the depth of the economic decline. But with the economy now in Phase 2 of reopening, business activity should start to gather pace. The government recently announced a $14.3bn multi-year investment drive to encourage innovation, on top of several more immediate stimulus packages already in place. And as a small, dynamic economy, Singapore may be well positioned to adapt to the new COVID reality.
While such investment will take a long time to play out, Singapore’s export sector is showing some signs of life. The headline export decline was in large part due to a collapse in oil exports, but the contraction in non-oil domestic exports was more contained at just 4.5% YoY. And, within this, electronics exports reported positive growth, while pharma exports also remain on an upward trend with a 35% gain in May on a 3m/3m basis (YoY comparisons are exceptionally volatile due to base effects). Both sectors could benefit from COVID, with increased global demand for pharma products globally and widespread working from home creating rising demand for electronics.
Despite an improving macro backdrop for Singapore, we do not expect SGD outperformance. The stock market has fallen by more than others in the region in recent weeks, and as a low yielder SGD will continue to take a back seat.
PMI Data in Focus
Next week’s June PMI surveys will be closely watched for signs of continued recovery, particularly in forward-looking components such as new orders. A strong recovery in flash European PMI readings this week has provided confidence that stimulus is working and that the economy can continue to rebound from the protracted slump. China’s manufacturing PMI is already back in expansionary territory (>50) and is set to remain so, while manufacturing PMIs in South Korea and Taiwan (currently in the low 40s) should continue to climb back closer to expansionary territory. Singapore’s composite Markit PMI is likely to take longer to recover given the phased reopening through June. For India, we expect the manufacturing PMI will show further recovery, albeit remaining firmly in contractionary territory, and that the services survey will recover slowly from April’s extraordinary decline.
Chart 8: Asia Manufacturing PMIs In Focus Next Week
(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.)