Asia’s encouraging currency stability
Three months ago to the day, the US Federal Reserve ended its outright purchases of treasuries. Three months before that, the ECB instituted negative interest rates. And whether by coincidence or causation, most commodity prices chose the past six months to unravel.
The combination of these events has led to some sharp exchange rate moves. Over the past three months, commodity currencies have been taken to the woodshed: the Russian ruble is down -37%, the Norwegian krone is down - 15%, and the Australian and Canadian dollars have each shed -11%. Meanwhile, the euro and its neighbours (Danish krone, Swedish krona, Polish zloty, Hungarian forint) are all down by -11% to -12%. And of course, the Swiss Franc made a never-before-seen one-day double digit gain against every other currency out there.
Amid the turmoil, Asian currencies have been islands of relative stability. In the last three months, the Philippine peso has risen by +1.3% against the US dollar. The Indian rupee and Thai baht are flat. The renminbi and Taiwan dollar are down -2.5%. Even the Japanese yen-every macro investor’s favourite short after the Bank of Japan’s October surprise-is down only -8%, and has basically been flat since mid-November. From this currency stability we draw the following conclusions:
* In 2014, the main story in the market was the strength of the US dollar. Starting in mid-November, the narrative started to shift from US dollar strength to euro weakness. This is important because the market’s behaviour in past few days following the European Central Bank’s announcement of quantitative easing raises the possibility that, once again, investors might have opted to ‘buy the ECB rumour, sell the fact’. Combine this with the recent underperformance of US equities, and perhaps the overall gains in the US dollar will now take a breather.
* One of the questions clients have asked most frequently over recent months is: When will the renminbi join other currencies-like the Singapore dollar last week-and devalue against the US dollar? But, if a) most Asian currencies are now stable against the US dollar, and b) the US dollar stops appreciating, should we be that concerned about renminbi weakness? In recent months, we have argued at length that Beijing needs its currency to be strong, at least against those of its neighbours, to further its long term geostrategic and financial reform goals. We still believe this to be the case and see short term pullbacks, such as the one that has unfolded in recent days, as a buying opportunity.
* The stability of Asia’s currencies makes the region all the more attractive both for domestic and foreign investors. Meanwhile, the greater currency volatility in Europe and other emerging markets massively increases the risk, and stress, for investors looking to deploy capital in either. At the margin, Asia’s currency stability should thus lead to a rerating of regional equities and bonds, relative to European and US equities. In fact, given the relative stability of Asian currencies and the region’s generally positive economic outlook, it makes little sense that Asian equities should currently be sporting the lowest P/E ratios in the world.
* The stability of Asian currencies is very positive for regional, and thus global, trade flows. Rapidly shifting currency values are highly disruptive for established trade links (as the Asian crisis of 1997-98 demonstrated). However, the fact that Asian countries do not seem to be following the lead set by others and are not playing the ‘currency war’ games is greatly encouraging for regional trade.
Putting all these points together, we take heart from the passable performance of Asian currencies over recent weeks. Admittedly, there have been spots of weakness: the Malaysian ringgit has had a tough few months (Malaysia is also the only Asian bond market to have delivered no gains over the past three months), as have the Australian and New Zealand dollars. But the pull-backs make sense given the importance of commodity extraction to these economies. And as the ringgit struggles, it makes sense for the Singapore dollar to soften somewhat in sympathy. But apart from these few cases, the picture that emerges from Asia is largely one of stability.
This relative currency stability will help the nascent Asian equity bull market to grow.
In fact, with an outlook very similar to the one at the beginning of this century, a number of Asian countries-India, the Philippines, China-may well be starting once again to see a triple merit scenario of falling interest rates, rising currencies, and rising asset prices.