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Asian Currencies Take a Tumble - Global Exchanges

FICC Podcasts March 15, 2022
FICC Podcasts March 15, 2022

 

In this episode, we discuss the biggest FX moves over the past few days, which are in USDJPY, USDRMB and correlated Asian currencies.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Greg Anderson:

Hi, welcome to episode 36 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. For this week's episode, my co-host Stephen Gallo and I will discuss the biggest FX moves over the past few days, which are in dollar yen, dollar RMB and correlated Asian currencies. The title for this episode is Asian Currencies Take a Tumble.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges presented by BMO capital markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York-based FX strategist. I'm Stephen's co-host.

Stephen Gallo:

In each weekly podcast like today's we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, it's affiliates, or subsidiaries.

Stephen Gallo:

Greg, it's March 15th, 2020. And really, the list of interesting things to talk about keeps getting longer. That's my feeling on this, in any case. Let's just take a look at the spot returns of the Asian currency complex since just prior to the start of the war in Ukraine. So at the bottom of the list, we have South Korea, which is lower by 4% since February 23rd.

Stephen Gallo:

Next is Thailand, slightly smaller decline. Japan and India's currencies are down just under 3% each. And the outperformers with either a tiny appreciation or a much smaller depreciation are Indonesia, Malaysia and China. And just for the record, the spot returns for the currencies in question are against the U.S. dollar.

Stephen Gallo:

For the most part, I think those returns can largely be explained by the relative vulnerability of those currencies to rising energy prices with the most vulnerable currencies at the bottom. And then moving up the list to currencies that have either a much more oil deficit in crude oil or a surplus and to currencies where the central bank is more actively involved in currency management.

Greg Anderson:

You mentioned the 4% rise in dollar Korea, and I'll point out that we're talking about a low volatility currency pair that had three-month vol trading on a six handle in January. So a 4% move in three weeks, that's a pretty big shock. And actually I argue that the 2.7% move in three weeks in the Japanese yen is a pretty big shock too.

Greg Anderson:

One of the things I would note in particular is the breakouts. And by a breakout, I mean, a move higher in the dollar that brings the exchange rate to new highs that haven't been seen for, let's say, at least six months. So among the Asian currencies, Korean won, new Taiwan dollar, Japanese yen, Philippines peso, they've all had breakouts thus far in March.

Greg Anderson:

But interestingly, Sing dollar, Indonesian rupee, Malaysian ringgit and then the Chinese RMB, they have not had breakouts yet. So there's one other thing that I want to point out. And that is the timing of the breakouts. The first two breakouts were in Korea and Philippines, and they both occurred on Friday, March 4th. Then the next breakout was in the Taiwan dollar on March 7th.

Greg Anderson:

Then we got the breakout in dollar yen on Friday, March 11th. And then after all of that, well, we finally got the big move in dollar China that we've seen thus far this week. And while it isn't a breakout by the definition I just gave, new dollar highs for six month period or longer, it is nevertheless a really big and noteworthy momentum shift for dollar Asia.

Greg Anderson:

And also, where the RMB is the biggest weight in the oft referenced ADXY index. We now have a breakout in that index with the breakout occurring yesterday March 14th. ADXY has traded today down to a new 16-month low.

Stephen Gallo:

Greg, I think you touched on a number of key points there. But where I'll pick up the conversation is just to say briefly that I don't think there are really many surprises in those currencies that have experienced breakouts. Given what's happened with energy prices. Of course, we know the region is very trade-dependent and faces rising input costs which may intercorporate margins.

Stephen Gallo:

Singapore, the fact that its currency hasn't had a breakout, the monetary authority of Singapore's policy regime is to manage the rate of depreciation or appreciation of the currency. And in any case, Singapore has an enormous external surplus. Indonesia has a very small trade deficit in crude oil as a share of GDP.

Stephen Gallo:

And a key supportive factor for the IDR is the improvement in the external position. And for example, the central bank's import coverage ratio since the 2013 taper tantrum. I mean, that was a big lesson for some of these central banks that were negatively affected by the Feds tapering of QE during the last decade.

Stephen Gallo:

In fact, if you go back as far as last September, Bank Indonesia was already broadcasting the fact that it was prepared for the Fed to taper QA. And then you have the Malaysian ringgit MYR, which is a small net exporter of crude oil. So it doesn't have a massive energy security issue. And that's pretty much the way the returns have stacked up.

Greg Anderson:

Good point, Stephen. And I'll just add that for the Japanese yen, we're talking about a country that had basically lost its trade surplus on the move in oil to levels above $70 a barrel. So with oil at $90 plus, we're likely to see a substantial trade deficit in 2022. And in fact, I wouldn't be all that shocked if even the current account balance moved into a deficit. That's not the only negative for the yen.

Greg Anderson:

The other half is the Fed rate hikes, which the Ukraine war doesn't seem to have taken off the table. The interest rate differential between Japan and the U.S. will continue to widen. And that should put a lot of upward pressure on dollar yen. I still think we'll get above 120 in the pair, and I wouldn't entirely rule out a move to 125. But Stephen, why do you think that the move in the RMB is smaller and coming later in the domino chain?

Stephen Gallo:

Greg, I think there are a bunch of explanations for the timing and relatively small size of the move in the RMB that you mentioned. One explanation is that China seemed to be on the receiving end of flows from Russia before the war in Ukraine. And now that the war has started, and now that Russia entities can't access their dollar accounts, they're drawing down on their RMB balances in China.

Stephen Gallo:

I think it's worth noting that the U.S. has now claimed that Russia requested military support from China. So without going too deep into this very sensitive issue, let's just for now call it murky. A second explanation for the move in the RMB, I think it's partly policy related. It looks like it's pretty clear to Chinese policy makers that downside risk to global growth have increased.

Stephen Gallo:

Initially Chinese policy makers wanted to project stability at the start of the war, but as the war dragged on and downside growth risks have increased policy makers also have to keep an eye on China's competitiveness, vis-à-vis, South Korea and Japan. So we're seeing a gradual and orderly realignment of the RMB in line with the domestic and international backdrops.

Stephen Gallo:

Greg, I have a couple of other angles I just want to throw out there. I think one factor which explains the small size of the move in the RMB thus far is the buildup of surplus FX liquidity onshore over the past one to two years, really since the start of the pandemic. And also, the degree to which policy makers have made it more costly for banks to lend dollars onshore.

Stephen Gallo:

So to me, that looks like preparation for an eventual Fed policy normalization. Meaning, I don't think there is a massive shortage of USD at the moment. And I don't think economic agents in mainland China are significantly short of dollars. Secondly, one other angle I'll point out.

Stephen Gallo:

I think China is more confident in the idea that the Fed is not going to start its tightening cycle aggressively. So it's able to ease policy with the exchange rate with a reduced risk of the move triggering a major appreciation of the dollar.

Greg Anderson:

So Stephen, what if I'm right and dollar yen goes all the way up to 125, where do you think dollar China would go?

Stephen Gallo:

Good question, Greg. And also very pertinent. Well, first off, we're comparing a low vol managed currency, the renminbi, with a freely floating higher vol currency the yen. So if dollar yen were to trade 125, I would give you something like 645, 650. I mean, it is very much a judgment call.

Stephen Gallo:

But what makes me cautious about predicting a big move in the RMB is that I think Chinese policy makers in this global environment are worried about an EM currency crisis. Not every EM currency, but outflows from EM currencies and distress in general. And I don't think they want to be the catalyst for an EM currency crisis. So that's what makes me a bit cautious. But definitely a knee-jerk move higher in dollar RMB if dollar yen goes to 125, Greg.

Greg Anderson:

Stephen, last discussion point. Euro China has bounced up pretty hard over the last couple of days. What's your view there on Euro China?

Stephen Gallo:

In the short-term, Greg, if we get another downturn in the Asian currency complex, Euro CNH will probably rally. But I think those rallies are good entry levels for medium-term Euro shore positions. I struggle to see the Asian block with its command and state-driven economies emerging from this very difficult economic period in structurally worse shape than Europe.

Stephen Gallo:

Even with the path towards a more integrated fiscal policy in Europe being outlined as a result of the war in Ukraine, you actually have to take a closer look at what is being integrated. And it looks like this push towards fiscal integration, it's going to coincide with enormous costs, more regulation, more taxation, a risk of a further influx of migrants from various regions, not just Ukraine.

Stephen Gallo:

And I think the Euro area is probably going to find that achieving merchandise trade surpluses will be much more difficult in the post globalization era. So I think for the most part you largely ignore the fact that the ECB is normalizing policy while China is in a modest easing cycle, because there are bigger fundamental drivers in play here.

Stephen Gallo:

And in any case, I struggle to see how the ECB can permanently step back from being involved in the bond markets whether the market's in question are the national sovereign debt markets or the market for EU issued bonds. Why don't we wrap up episode 36 here, Greg. Until next time, thanks for listening. Bye.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

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Greg Anderson Global Head of FX Strategy
Stephen Gallo European Head of FX Strategy

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