Weekly: Rising Asian FX volatility and vulnerability
- The dollar index could rise further due to worldwide economic and political uncertainty
- Asian currencies with heavy external funding needs could struggle in this climate
- India’s election outcome underscores policy continuity for the next five years
Trade wars take their toll on regional currencies
The worrisome escalation in trade wars is causing global investment and trade momentum to weaken, but even before data related to those activities become available, currency markets have been reflecting the rising gloom and uncertainty.
China, facing one salvo after another from the US on a nearly daily basis, has seen a sharp rise in CNY volatility. Some intervention in the in offshore market may have arrested the volatility in the last few days, but it is natural for the currency to sell off as the export sector faces a myriad of shocks, ranging from tariffs to severe restriction to US markets for high tech industrial inputs. Registering a 3% slide against the USD in the past month, the CNY is primed to head toward 7 in the coming days as hope for a trade war truce fades and China’s growth momentum weakens.
Since the US Fed monetary policy about-turn in late December, global liquidity conditions had eased, but the renewed escalation in trade tensions has begun to erode those gains. Measures of USD funding conditions show a steady tightening in recent months. As the markets face tighter USD liquidity despite an accommodative Fed, financial conditions will invariably tighten. This may cause for further demands for the Fed to cut interest rates, but until that happens (and we think it is unlikely to happen any time soon, unless global markets sell off sharply and in a disorderly manner), we will expect sustained USD strength against both EM and DM currencies.
Currency volatility has begun to rise, although vols are nowhere close to what was seen last summer. The path ahead is one of higher volatility, in our view, as on-again-off-again developments in trade negotiations, Brexit, Iran, and US politics keep the markets lurching from one direction to the other. Currencies of the UK, Turkey, and Argentina have idiosyncratic reasons for selling off, but a broader narrative to depreciating against the USD has emerged, in our view. As long as the US remains hyper assertive in foreign and trade policies, and domestic economic momentum remains broadly unchanged, the dollar-favourable environment is unlikely to shift.
Here in Asia, there is quite a bit of vulnerability with respect to external financing. Below we update our funding gap calculations. Our favoured metric is gross external funding, which is the sum of current account balance forecast and all hard currency debts due in a given year. The ratio of central bank FX reserves to gross external funding needs is therefore a useful gauge of currency vulnerability.
Updating our calculations for 2019, we find that funding cover has generally declined in the region, one exception being Thailand. Although South Korea, the Philippines, and China have sizeable cover for externa debt, their ratios have nonetheless fallen markedly in recent years.
India, Indonesia, and Malaysia’s currencies are the most vulnerable, by this metric, and have remained so despite some build up in reserves in recent years. We will keep our eyes on these three currencies, plus the CNY, during the course of what is likely to be a summer of discontent.
To read the full report, click here to Download the PDF.
The information herein is published by DBS Bank Ltd and PT Bank DBS Indonesia (collectively, the “DBS Group”). It is based on information obtained from sources believed to be reliable, but the Group does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Group, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Group or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Group & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified.
DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E.
PT Bank DBS Indonesia, DBS Bank Tower, 33rd floor, Ciputra World 1, Jalan Prof. Dr. Satrio Kav 3-5, Jakarta, 12940, Indonesia. Tel: 62-21-2988-4000. Company Registration No. 09.03.1.64.96422.