Dollar ‘tantrum’ rears its ugly head again
AS Malaysians prepare to go to the polls, emerging-market currencies and the stock market are falling under the weight of the appreciating US dollar and the rise in US interest rates.
The dollar index, which measures the strength of the greenback against a basket of developed-nation currencies, is well above the 90-point mark. The highest in recent times was the dollar index hitting 103 points in December 2016 after Donald Trump won the US presidential election.
The benchmark FBM KLCI, which covers 30 of the largest stocks on Bursa Malaysia, is down 1.37% in the last three months. However, Malaysia has so far fared better compared to other markets in the region.
The Jakarta Stock Exchange, which is down 12.65% in the last three months, is the worst performer in the region. The Hang Seng and Shanghai indices are down by 8.5% and 10.7%, respectively.
Among Asian countries, Indonesia is facing the brunt of foreigners paring down their interest in the region. There is a major sell-off in the stock and bond markets of Indonesia.
Nevertheless, so far, most Asian countries and currencies are faring much better than the Latin American countries.
The Argentine peso is the worst performer, down 11.41% over the last one month. This is despite the Argentine government raising interest rates by 6% in a space of one week to 33.24%.
With the interest rate at 33.24%, one wonders how businesses are able to operate. In fact, there is little incentive for people holding excess cash to work because of the high financing environment.
Text-book economic theory states that when interest rates are high, it would help the currency appreciate.
However, the irony is that the high interest rates have contributed to the slide in the Argentine peso. The Argentine peso has lost more than 11% of its value against the US dollar in the last one month.
The Argentine peso, Turkish lira and Russian rouble are among the worst hit in the current round of the US dollar appreciation, as investors take money off from these countries.
The dollar is well-positioned to strengthen further on the back of the Federal Reserve raising interest rates in its next sitting in June. At the moment, the 10-year US treasury yields are just a whisker away from touching 3%.
At 3%, it is easy to fathom why money is going back to the US. Investors not only gain a 3% yield but also enjoy the potential appreciation of the dollar. In total, the returns would be more than 4%.
The US dollar is poised to continue its appreciation path. This is on the back of the Fed raising interest rates two more times this year and another three times next year. A year from now, US interest rates would likely be at least 3.25% and the yields on the 10-year US Treasury would easily be closer to 4%.
However, it is not all gloom and doom for Asian emerging markets such as Malaysia.
At the moment, the ringgit is under pres- sure because the economic momentum is slowing down. Exports in the months of February and March were down.
However, countries such as Malaysia have learnt the harsh lessons from the 1998 economic crisis and have taken pre-emptive steps to prevent from being exposed to the US dollar risk. Most Asian countries do not have large US dollar-denominated debts, unlike some countries in Latin America.
In an environment of rising interest rates, debts denominated in US dollars become more expensive to service.
The likelihood of default becomes higher. The fear of default is chief among reasons why countries such as Argentina have seen their currencies falling sharply despite the high interest rates.
The rising interest rate has resulted in foreigners selling off the bonds and stocks in emerging markets and going back to the US. This is what is termed as the “unwinding” of the carry trade, where investors borrow in currencies that offer low interest rates and invest in assets that offer high yields.
In the last few years, funds have taken advantage of the spread between the US and Asian interest rates. They borrow in the US where the interest rate is low and buy up bonds and stocks in emerging markets that offer high yields. The “spread” or what is known as the difference in returns is up to 2%.
The “spread” has narrowed in the last six months as the yields of US 10-year Treasury bills have gone up. This has prompted the unwinding of the carry trade, which will continue to haunt emerging-market currencies.
However, in countries such as Malaysia where foreign investors hold little debt papers, the risk of a sharp fall in the ringgit is low. However, the ringgit will continue to come under pressure as long as the economic momentum is slowing down.
A clear indication of when the ringgit would rise is the export figures. When exports pick up again, the ringgit would be in a more comfortable position to counter the rise of the dollar.