Weekly: Rising Asian FX volatility and vulnerability

Trade war is intensifying and broadening, and regional currencies are facing the brunt of the rise in uncertainty and downside risks.
Taimur Baig, Ma Tie Ying24 May 2019
  • 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
Photo credit: AFP Photo

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.

Taimur Baig, Ph.D.

Chief Economist - G3 & Asia



Ma Tieying

Economist - Japan, South Korea, & Taiwan

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